Coles will become an independent company for the first time in 10 years after owner Wesfarmers announced it would spin-off of its $18 billion supermarket chain to focus on its remaining retail empire and acquiring new businesses.
Wesfarmers managing director Rob Scott said ownership of Australia's second largest supermarket business had helped the conglomerate outperform the market since it bought the Coles Group for $19.3 billion in 2007.
Coles will face a new life as a separate entity.Credit: Michael Clayton-Jones MCJ
Mr Scott said that while earnings would continue to grow at Coles' supermarkets, bottle shops, service stations and hotels, it would not be at a rate that Wesfarmers' wanted from its businesses.
“Coles is a business that still has a lot of growth ahead of it, but you wouldn't expect it to achieve the same growth rate that we achieved over the first decade of ownership given that we went through a very significant operational turnaround," Mr Scott said.
“This portfolio move today is very much about setting up the Wesfarmers group for the next decade."
Coles accounts for 60 per cent of Wesfarmers tied-up capital but generates only 34 per cent of its earnings, the company said. Wesfarmers' purchased Coles almost a decade ago at a time when the supermarket chain was struggling.
The deal was at the time Australia's biggest corporate takeover, revived Coles fortunes, although a resurgent arch-rival Woolworths has put pressure on the company over the past two years.
Wesfarmers said the spin-off would allow it to focus on growing its other divisions, which include Bunnings, Kmart, Target and Officeworks, and look for opportunities to buy new businesses.
Investors, analysts and the market applauded the move, saying shareholders could get more exposure to Wesfarmers' star business, Bunnings, which will make up almost 60 per cent of earnings after the demerger.
Wesfarmers shares surged 6.3 per cent to close at $43.80 - their biggest one day jump since October 2009.
Shares were trading at highs of $44.94 in December by plunged in February after it revealed a $1 billion write down to the value of its Bunnings hardware venture in the UK and Ireland.
Analysts valued a spun-off Coles at around $18 billion.
The demerger comes as Coles fights to regain momentum lost to Woolworths, which has beaten it on sales growth for five consecutive quarters, while also coming under pressure from Aldi as the discount store grows its footprint and customer base.
Coles' earnings before interest and tax slid 14 per cent to $790 million in the most recent half, falling behind Bunnings' earnings ($864 million) for the first time.
Wesfarmers had been considering spinning off Coles for several years, and Mr Scott said he had discussed it with former chief executive Richard Goyder before he took over in November last year.
But the market had been too challenging up until now, he said.
Wesfarmers' prides itself on shareholder returns, and Mr Scott said the Coles business had met its cost of capital while helping Wesfarmers record a total rate of return since June 2007 of 114 per cent, compared to 52 per cent on the ASX200.
However that trend has reversed in recent years, leading to Mr Scott's decision to try and find new ways to generate earnings growth.
Wesfarmers' shareholder returns over the past five years (share price appreciation plus dividends) is 35 per cent, compared to the market's 44 per cent. Over the past two years its rate of return is 15 per cent, compared to 26 per cent on the ASX200.
Wesfarmers' 530,000 shareholders will receive shares in the new Coles company in proportion to their existing holding.
Wesfarmers will retain up to 20 per cent of shares in the new Coles company to support "strategic alignment", including in digital, data analytics and the flybuys loyalty program.
However, Mr Scott said if the announcement "happens to flush someone out with a very big chequebook" he was open to selling Coles instead.
The two business would have different investment profiles, Mr Scott said, with Coles delivering earnings growth with "defensive characteristics", and Wesfarmers offering greater opportunities for big returns by buying new businesses and growing its existing ventures.
Wesfarmers also announced current Coles managing director John Durkan will step down later this year after four years in the top job. He will be replaced by Steven Cain.
Mr Durkan said he first discussed stepping down with Wesfarmers' former boss Richard Goyder 18 months ago, and that it was the right time for Coles to have a new leader who was "prepared to commit to long-term tenure and navigate this great Australian company through the next chapter of its history".
Mr Cain is currently the head of supermarkets at Metcash, which supplies IGA supermarkets, and advised Wesfarmers on its takeover of the Coles Group in 2007. The news sent Metcash's shares more than 5 per cent lower to $3.01 in morning trade.
Woolworths' shares also rose on Friday, to close up 1.25 per cent, with analysts saying an independent Coles was less likely to reignite the damaging price war seen earlier this decade without the backing of Wesfarmers and while being run by Mr Cain, who was more focused on merchandising, costs and efficiency than price.
The Coles spin-off will include Coles’ 806 supermarkets, 894 bottle shops under the Liquorland, Vintage Cellars and First Choice Liquor brands, 712 Coles Express service station and convenience outlets, Coles Financial Services, which sells credit cards and insurance, and its 88 hotels, which are mostly in Queensland.