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Coles Group Ltd (ASX: COL) shares have experienced a decline of more than 10% over the past six months, signaling potential economic challenges for the ASX-listed supermarket chain, especially if consumer prices begin to fall.
In recent years, there were periods where investors were optimistic about Coles' ability to pass on price increases to consumers. During FY23, the company managed to slightly increase its gross profit margin, indicating its success in raising prices slightly more than what suppliers charged. ASX consumer stocks, including Coles, have been closely monitored amid shifts in consumer sentiment and pricing dynamics. Coles' ability to maintain and slightly improve its gross profit margin reflects its resilience within the consumer sector and its adeptness in navigating pricing pressures.
Maintaining or increasing the earnings before interest tax (EBIT) margin while benefiting from revenue growth due to inflation can be advantageous for Coles. For instance, if Coles' EBIT margin remains at 5% and the basket price rises due to inflation, the company's bottom line would strengthen, even without a change in the margin.
However, recent reports suggest that food prices could potentially decrease. Coles has already reduced prices for certain products like lamb, and there are considerations for further price cuts, partly driven by political pressure from a federal Senate inquiry into supermarket prices.
According to The Australian, Coles has requested price reductions from some suppliers to reflect declining inflation and lower input costs. However, some suppliers may resist these requests to protect their own profits.
In its submission to the Senate inquiry, Coles highlighted significant cost increases in energy, labor, logistics, and packaging, amounting to $1.4 billion between 2019 and 2023. While some input costs have decreased, rising wage and rent expenses pose challenges for Coles.
If Coles experiences lower profits due to potential price deflation, it could negatively impact its share performance. Additionally, brokerage firm UBS predicts that Coles may lose market share in the coming months, with competitors like Aldi and Woolworths poised to gain.
Furthermore, Coles may face increased costs from its new automated warehouses. UBS forecasts a decline in Coles' EBIT and net profit after tax (NPAT), leading to a reduction in the dividend per share. However, earnings are expected to recover in FY25 and surpass FY23 levels by FY26.
Overall, the potential for declining consumer prices and increased competition may pose challenges for Coles in the short term, but recovery is anticipated in the medium to long term.
