Down almost 20% in 3 months, is the Coles share price an undervalued buy?

Should investors actually be looking at Coles right now?

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The Coles Group Ltd (ASX: COL) share price has fallen close to 20% since 27 July 2023, as we can see on the chart below. Should the ASX supermarket share be seen as an opportunity with it trading at a 52-week low?

It's interesting that the business has been falling even though food inflation still continues at a higher rate than pre-COVID times, which is a useful tailwind for sales.

However, while inflation is a boost for revenue, it's a headwind for other costs such as wages. The company is one of the biggest employers in the country, so a sizeable rise in wage costs is a drag on profitability and seemingly the Coles share price in the last couple of months.

Higher interest rate costs could also be a drag on the longer-term profitability of Coles because its debt could become more expensive, particularly as it invests heavily in its new technological warehouses.

Why I think it's an opportunity

There is probably going to be a lot of volatility over the next few months as investors take into account the latest inflation numbers, any RBA moves and global events.

But, Coles seems like the sort of business that can be a steady compounder over time. The Australian population is rapidly growing at the moment, with statistics showing that the last 12 months may have seen 500,000 more people migrate into the country.

More people in the country should mean more mouths to feed, which is a useful tailwind for Coles. It can enable the business to open more supermarkets without oversaturating the market.

It's very difficult for a business to challenge Coles, Woolworths Group Ltd (ASX: WOW), Aldi and Metcash Ltd (ASX: MTS) because of the market strength of those businesses.

The business has a strong economic moat and useful tailwinds for revenue, so I think the short-term weakness we've seen can be an opportunity to invest for the longer term.

Coles share price valuation and dividend yield

According to the estimates on Commsec, the company is predicted to generate earnings per share (EPS) of 74.8 cents, which puts the Coles share price at 20 times FY24's estimated earnings.

It's projected to pay an annual dividend per share of 61.4 cents, which would be a grossed-up dividend yield of 5.9%.

Profit and the dividend could then bounce upwards in FY25, according to the projection on Commsec.

I think these predicted numbers for FY24, which suggest a decline, make me believe it's a solid blue chip to own in a portfolio.

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 Australia has recommended Metcash. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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