About: Coles Group Limited is a major Australian retailer with extensive retail interest throughout Australia and New Zealand. Its main operations include supermarkets, liquor, fuel stations and financial services via its store network and online platforms. As at 30 June 2018, Coles processed more than 21 million customer transactions on average each week and operated 2,507 retail outlets nationally.

Why it’s in the portfolio: Together with Woolworths (WOW), Coles Group represents a quasi-duopoly on the Australian retail sector. As such, Coles provides investors with a diversified and wide-raging exposure to the Food & Staples Retailing sector of the Australian economy. After experiencing difficulties in most of its business units coming in to 2018, Wesfarmers (WES) de-merged the Coles Group (including Liquorland, First Choice Liquor and Coles Express fuel stations) in a separate listing (while Bunnings, Kmart and Target remained with WES). Freed from its parent company, COL is well positioned for a return to growth, led by revitalised supermarket and online sales. It also appears to be much more attractively priced than its closest competitor WOW.

Fundamentals: COL currently trades on a price-to-earnings ratio of around 20x forward earnings (vs. 24x for WOW, which is close to 2 standard deviation away from its long-term average of 18x), and a price-to-book ratio of 3.5x (similar to WOW’s 3.8x). Coles currently offers around a 2.8% gross dividend yield (vs. 4.5% for WOW), and a dividend payout ratio of 55% (vs. 75% for WOW). At 20%, COL’s debt-to asset ration is considered to be relatively low.

What could go wrong? While Consumer Staples companies are typically less sensitive to weakening economic conditions, Coles operates in a competitive environment. Over the last few years, it appears Coles has gained ground against its main competitor Woolworths, culminating in the closing of its Masters business. These good news are reflected in current pricing and there is no guarantee that Coles will be successful in continuing this trend. Coles Group’s future growth and profitability could be further threatened by the growing imprint of foreign retailers in the Australian landscape (e.g. Aldi, Lidl, and Amazon).