The pros and cons of buying Coles shares in November

Should investors own the supermarket stock or avoid it?

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a woman ponders products on a supermarket shelf while holding a tin in one hand and holding her chin with the other.

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When ASX blue-chip shares are sold off, the lower valuation can present an investment opportunity. That's the conundrum investors face with Coles Group Ltd (ASX: COL) shares right now. The Coles share price has dropped 7% since 20 September 2024.

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While that's not a huge fall, I think it represents a decent decline considering the S&P/ASX 200 Index (ASX: XJO) has climbed 1% over that same time period. It's a significant underperformance, in my opinion.

Of course, past performance is not a reliable indicator of future performance; it's possible that Coles shares could outperform again.

However, let's start by looking at the reasons why investors may want to avoid Coles shares for now.

Negatives about Coles shares

Investors gained a number of insights into Coles' performance when it reported its FY25 first-quarter update.

Inflation, excluding tobacco and fresh categories, reduced to just 0.1%, compared to 6.3% in the first quarter of FY24. Lower inflation is good for households, but it also means Coles' sales growth has slowed from what it was last year. Coles supermarkets reported comparable sales growth of 2.4% in the FY25 first quarter, down from 3.6% growth in the prior corresponding period.

Broker UBS said in a note to investors that while Coles was able to manage the consumer shift to value better than Woolworths Group Ltd (ASX: WOW), customers' higher usage of promotions, more private label sales, and higher online sales all had "negative impacts on gross margin" and the cost of doing business (CODB) to sales ratio.

Coles and Woolworths also face significant political and ACCC attention. The ACCC is currently taking legal action over supermarket discounts that may or may not be true discounts. If Coles loses the case, any financial penalties could be costly for the company and perhaps Coles shares. But Coles is defending itself by saying suppliers were asking for large price increases.

But now, let's look at why the supermarket giant could be attractive.

Here are the positives…

When valuations fall, it can make a stock more attractive. When a growing business like Coles drops, I get more interested.

While inflation has reduced, Coles has continued to deliver sales growth, which I think is a good sign that the business can continue to grow earnings. FY25 total first-quarter sales rose 2.9% to $10.55 billion, and total supermarket sales increased 3.5% to $9.5 billion. Within that sales number, supermarket e-commerce sales soared 22.4% to $1.04 billion, though it only represents a small portion of the overall sales at this stage.

One of the main reasons to like Coles shares is the Witron automated distribution centres (ADCs). At a recent investor day, the supermarket business highlighted the advantages of the ADCs. It also recently announced another one will be built in Victoria.

Broker UBS noted that Coles reported Witron ADCs improved the availability in NSW and Queensland by between 20% to 25% while also driving transport efficiency, availability and inventory accuracy in stores and customer fulfilment facilities. It's also leading to lower costs and increased productivity.

UBS also noted Coles is targeting at least 1.5% space growth with around 14 new stores per year.

Another positive to owning Cole shares is its growing dividend. UBS forecasts the Coles dividend per share could rise to 72 cents per share in FY25, which would represent a grossed-up (including franking credits) dividend yield of 5.8%.

Overall, I think now is a good time to invest in Coles shares.

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.

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