A soft first-half result has been the main catalyst in the Coles Group Ltd (ASX: COL) share price falling 1.4% to $11.58 in 2019. In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) has risen 9.8%.
This means the recently listed Coles has underperformed the main benchmark by 11.2% in 2019.
Top-line grows but margins contract
On a retail calendar basis, overall sales revenue for Coles increased by 2.6% to $20,867 million for the first half of FY19. Earnings before interest and tax (EBIT) and before any significant items decreased 5.8% to $733 million as EBIT margin contracted by 31 basis points to 3.5%.
Management attributed the decrease in EBIT to lower earnings from Coles Express and additional corporate costs involved with being a standalone listed entity on the ASX following the demerger from Wesfarmers Ltd (ASX: WES) in November 2018.
The supermarkets division delivered its 45th consecutive quarter of comparable sales growth. It reported comparable store sales growth of 3.0% with sales revenue climbing 3.6% to $16,195 million. However, EBIT margin fell 12 basis points to 3.7% that resulted in segment EBIT increasing by only 0.4% to $602 million.
The main culprit for the decline in group EBIT was from Coles Express which saw softer trading as transactions were impacted by a 15.8% fall in fuel volumes and unfavourable weather. As a result, sales revenue declined 1.8% to $2,941 million and EBIT decreased by 39.3% to $51 million.
Forward earnings downgraded
Following the release of a subdued first-half result, the consensus estimates for Coles' forward earnings have been revised downwards. The consensus earnings per share estimate for FY19 has declined 7.0% to 66.57 cents, and the consensus FY20 estimate has fallen 11.0% to 67.02 cents.
Thus, at current prices, Coles is trading for around 17 times FY20 earnings for a business that is projected to grow earnings at a rate of less than 1%.
Foolish takeaway
The duopoly dominance that Coles and Woolworths Group Ltd (ASX: WOW) have enjoyed in the Australian supermarket sector has weakened over the last several years with the increase in competition from Aldi and Costco among others.
The increased competition in the industry has resulted in margins materially contracting. In the first-half of FY14, EBIT margin at Coles' Food & Liquor was 5.1% versus the 3.8% EBIT margin reported at Supermarkets & Liquor for the first-half of FY19.
Coles remains a stock that appeals to income investors due to the defensive nature of the business and its high dividend. However, at 17 times forward earnings the stock is not cheap when factoring in expected growth rates.
In light of the current operating environment in the Australian supermarket industry and its future growth prospects, there is no rush to buy Coles shares at its current valuation in my view. A better opportunity would present itself to income investors in the event of a market correction.
