Why Coles stock could face increasing margin pressure

Has the supermarket business been put in the bargain bucket?

| More on:
A man pushes a supermarket trolley with phone in hand down a supermarket aisle looking at the products on the shelves.

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Coles Group Ltd (ASX: COL) stock has suffered in the last few months. The company's share price is down around 15% from 1 August 2023, as we can see on the chart below.

Created with Highcharts 11.4.3Coles Group PriceZoom1M3M6MYTD1Y5Y10YALL31 Jul 202322 Sep 2023Zoom ▾31 Jul7 Aug14 Aug21 Aug28 Aug4 Sep11 Sep18 Sep7 Aug7 Aug21 Aug21 Aug4 Sep4 Sep18 Sep18 Sepwww.fool.com.au

That compares to a decline of around 5% for the S&P/ASX 200 Index (ASX: XJO) over the same time period.

In prior months, the business had been benefiting from inflation as the company passed on food price rises from suppliers to customers. If the business is able to maintain its profit margins, then rising revenue should translate into growing profit as well.

However, the difficulty is that Coles' profit margins may not keep rising, according to one fund manager.

Profit margins to come under pressure?

The lead portfolio manager of WAM Leaders Ltd (ASX: WLE), Matthew Haupt, recently wrote about how cost inflation was a "hallmark" of the most recent ASX reporting season. He argued its effects could be seen across higher labour, rent, energy, and transport costs which are becoming "increasingly baked into corporate earnings, all but ensuring margin compression" over the next year.

The Wilson Asset Management (WAM) investor sounded a warning about businesses, such as Coles, that have high labour expenses as a proportion of their total cost base. Haupt suggested that unless these businesses can "dramatically reduce head count", the much higher labour cost can't be offset. He noted this will also impact ASX bank shares more than the ASX mining shares.

The fund manager said the full impacts of wage inflation are yet to hit company earnings and Coles is facing "significant wage inflation on labour-heavy cost bases".

If revenue is slowing, then it becomes even harder for businesses to maintain their profit margins, so WAM Leaders is focused more on companies that have the ability to manage their costs through the cycle.

The fund manager also pointed out there is a rising cost of debt for businesses.

All of this suggests the short-to-medium term may be challenging for Coles stock.

What has Coles said?

FY23 saw Coles' sales revenue increase 5.9% to $40.5 billion, yet net profit after tax (NPAT) fell 0.3%.

In the outlook, the company said in the early part of FY24, supermarket volumes remained "modestly positive" compared to the prior corresponding period. Headline inflation has "continued to moderate" though inflation in bakery, grocery, and dairy remained "consistent with the fourth quarter".

Coles has said its stock loss is a "priority" and it's taking immediate action, such as increasing security at high-risk stores.

It also noted the recent increase in the Victorian payroll tax is estimated to have an impact of approximately $20 million per annum, while the Fair Work Commission annual wage increase means store remuneration "will increase by 5.75%".

Coles stock price valuation

According to Commsec, the Coles share price is valued at 21 times FY24's estimated earnings.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has positions in and has recommended Coles Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Consumer Staples & Discretionary Shares

A happy farmers sifts his fingers through grain, indicating a good crop and higher prices.
Consumer Staples & Discretionary Shares

Why GrainCorp is Macquarie's top pick in the ASX agriculture sector

GrainCorp is Macquarie’s top ASX Ag stock pick and for good reason.

Read more »

a man inspects a capsicum while holding an eco-friendly green string bag in a supermarket produce aisle.
Consumer Staples & Discretionary Shares

Coles shares: Buy, hold, or sell?

Three investment experts offer their take on the outlook for Coles shares.

Read more »

A man stands with his arms folded in front of banks of unused poker machines in a darkened gaming room.
Consumer Staples & Discretionary Shares

Does Macquarie see more upside for these ASX gaming shares?

Macquarie expects a 42% upside from one of the stocks.

Read more »

Ecstatic woman looking at her phone outside with her fist pumped.
Consumer Staples & Discretionary Shares

Why are Lovisa shares jumping 6% today?

Let's see what was announced to the market this morning.

Read more »

A man sits in a chair hunched over a laptop and covered head to toe in frozen icicles to represent Envirosuite's trading halt
Consumer Staples & Discretionary Shares

PointsBet share price frozen amid takeover update

Is a superior proposal on the way?

Read more »

High fashion look. glamor closeup portrait of beautiful sexy stylish Caucasian young woman model with bright makeup, with red lips, with perfect clean skin.
Consumer Staples & Discretionary Shares

Is the consumer discretionary sector back in favour after interest rate cuts?

One broker has named its best buys.

Read more »

A male investor wearing a blue shirt looks off to the side with a miffed look on his face as the share price declines.
Consumer Staples & Discretionary Shares

Treasury Wine shares tumble on big US news

10% of its net sales revenue is under threat because of this news.

Read more »

group of students working together
Share Market News

Guess which ASX 200 stock is crashing 38% on market update

This stock is having a day to forget on Tuesday. Let's find out why.

Read more »