Coles Group Ltd (COL) $18.03

Last week, we looked at rival Metcash, but as so often occurs, a lot can happen in a week!  It is old news now how Woolworths (WOW) and Coles Group (COL) have fallen foul of the ACCC with over $4bn wiped off their combined market cap since the regulator accused them of telling shoppers they had dropped prices when they had actually increased them before they subsequently reduced them – doesn’t sound too good. The public regard of the big supermarkets is reminiscent of the banks during their regulatory scrutiny a few years ago, and with an election looming next year, politicians are likely to compound the mood in search of votes.

However, the banks have rallied substantially from their lows after the banking enquiry 2017-19, and it could be the same for the major supermarkets this time, although the current process is likely to be much faster. Public opinion is expected to fall further as the ACCC findings are released, but where else will we shop? Nowhere in MM’s opinion. Aldi and independents are definite beneficiaries, and in today’s tough financial times, some consumers now do their primary shopping at Aldi and cherry-picking promotions at WOW & COL, leading to smaller basket sizes with higher promotional participation rates, at the majors, i.e. reduced margins. But over time, other tailwinds are likely to more than offset this small dent in earnings.

The fines will likely be huge, with various eye-catching numbers tossed around. Hence, with uncertainty surrounding both, if MM were to buy the current pullback, we would like to do so on a cheap valuation—therein lies the issue. Coles, which has been our preferred pick of the two majors through 2024, is only trading 5% below its average P/E of the last 5-years, which is “ok” when we consider how briefly it’s dipped below 20x in recent years, but today its public enemy number one, or two, and it still feels rich, considering what’s unfolding.

• MM likes the risk/reward towards COL when it’s trading on a P/E sub 20x.

COL could currently be referred to as a “high-risk” defensive play, with the courts set to determine the short-term pain from its price manipulation. One of the interesting factors here is the supermarkets operate in an environment without clear rules around price establishment; hence, they haven’t broken the rules per se, i.e. they did “ABC, which brings with it a fine of XYZ.” Markets hate uncertainty, and that’s precisely what we have today.

One potential longer-lasting, negative outcome of this ACCC enquiry (markets generally look through one-off fines) is that Australian supermarkets may ultimately be told how to conduct business regarding pricing. Again, don’t forget the significant impact of the Banking Royal Commission that took years to overcome – once you’re in the regulator’s crosshairs, it will cost money—the only question is how much!

• We prefer COL over WOW in line with their recent trading updates, but even after recent falls, valuations aren’t compelling just yet.