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.
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.
