Why I think Coles shares are a top buy for ASX dividend investors

Coles could be an underrated pick for dividends.

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Key points
  • I think that Coles may be a defensive pick for income-focused portfolios
  • Despite inflation pressures, Coles is expected to grow earnings and dividends in the next two years
  • The FY24 grossed-up dividend yield could be 6.1% based on projections

Coles Group Ltd (ASX: COL) shares could be a leading pick for dividend income in the coming years.

It has already started an impressive dividend streak, growing its annual dividend each year since it was divested from Wesfarmers Ltd (ASX: WES) in FY19.

There are not too many S&P/ASX 200 Index (ASX: XJO) shares that grew their dividend in 2020 as the COVID-19 pandemic caused financial difficulties for many businesses and sectors.

But, Coles was one of the impressive few that did grow its dividend in 2020. And 2021. And 2022.

A laughing woman pushes her friend, who has her arms outstretched, in a supermarket trolley.

Image source: Getty Images

How much did the Coles dividend increase in FY22?

The Coles board decided that the final dividend of FY22 would be 30 cents per share. That was an increase of 7.1% year over year.

The Coles interim dividend was maintained at 33 cents per share. So the full-year dividend of 63 cents per share was an increase of 3.3% compared to FY21's payout.

A 7.1% increase for the last six months of the 2022 financial year was a good increase. What's more, it represented a rise that was faster than inflation.

Coles' revenue is benefitting from the increase in inflation because it means customers are paying more for the same basket of products going through the checkout.

However, Coles' costs aren't immune to an increase as well. Coles commentated on its FY23 outlook:

We have seen further cost price inflation in produce due to recent flooding, in bakery due to wheat commodity prices, and in packaged groceries due to various supply chain cost increases including wages, packaging, raw ingredients and freight.

Consistent with our suppliers and customers, we are also seeing inflationary pressures impacting our own cost base with increasing wages, rent, fuel, supply chain and capital costs. In addition, COVID-19 and the flu has seen increased team member absenteeism costs continue to impact the business.

What could this mean for future dividends?

Coles is expected to achieve profit growth and dividend growth in FY23 and FY24. This could be a useful driver for the Coles share price. We all need to eat food, so I believe Coles could be a defensive choice for the next few years.

In FY23 it will be cycling against the sales boost of lockdowns in the first half of FY22 and inflation in the second half of FY22. However, Coles Express can benefit from increased mobility now that lockdowns have finished. And higher fuel prices are another factor to consider.

In FY22, Coles' earnings per share (EPS) increased by 4.6% to 78.8 cents. Using the estimates on CMC Markets, Coles is expected to grow its EPS slightly to 81.7 cents in FY23. Then it's expected to achieve more growth in FY24 as EPS increases to 87.7 cents.

The profit growth is expected to help fund higher dividend payments.

In FY23, Coles is expected to grow its dividend by 6% to 66.8 cents per share according to the numbers on CMC Markets. Then, Coles is predicted to increase its dividend by another 6.3% to 71 cents per share.

If these predicted numbers come true, then the FY23 grossed-up dividend yield could be 5.7% and the FY24 grossed-up dividend yield could be 6.1%.

Foolish takeaway

With the Coles share price down by 14% over the past month, I think this could be an opportunistic time to consider this supermarket business which is investing for growth, including its large, heavily-automated warehouses that could boost efficiencies and margins.

I believe it's building a promising reputation as an ASX dividend share.

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 COLESGROUP DEF SET and Wesfarmers Limited. 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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