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Edited Transcript of COL.AX earnings conference call or presentation 22-Aug-19 12:00am GMT

Full Year 2019 Coles Group Ltd Earnings Call

Aug 24, 2019 (Thomson StreetEvents) -- Edited Transcript of Coles Group Ltd earnings conference call or presentation Thursday, August 22, 2019 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Leah Weckert

Coles Group Limited - CFO

* Steven Cain

Coles Group Limited - MD, CEO & Director

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Conference Call Participants

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* Andrew J. McLennan

Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst

* Ben Gilbert

UBS Investment Bank, Research Division - Executive Director and Analyst

* Bryan Raymond

Citigroup Inc, Research Division - VP & Analyst

* David Errington

BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia

* Johannes Faul

Morningstar Inc., Research Division - Equity Analyst

* Phillip Kimber

Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst

* Rod Sleath

Rimor Equity Research Pty Ltd - Equity Analyst

* Shaun Robert Cousins

JP Morgan Chase & Co, Research Division - Senior Analyst

* Vanessa Jeffriess

Macquarie Research - Equity Research Associate

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Coles Group Limited Full Year Results 2019 Conference Call. (Operator Instructions)

At this time, I'd like to turn the call over to Mr. Steven Cain, CEO of the Coles Group. Please go ahead.

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Steven Cain, Coles Group Limited - MD, CEO & Director [2]

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Thank you and welcome to the Coles 2019 full year results announcement.

For those of you that don't know me, I'm Steve Cain, the Chief Executive Officer of Coles. I'm joined by Leah Weckert, who is our -- as many of you know, our Chief Financial Officer.

I'm just going to take you through a high-level summary today, not the full presentation deck, before handing over to Leah to take you through the headline financials.

Obviously, we had our Investor Day in June, and this is really an update on how we're traveling. If we go to Slide 3, you can see that F '19 has been a transformative year for Coles, bookended by 2 key events which was the demerger in November and then our Investor Day in June.

If you look at the key financials, sales from ongoing operations increased by 3.1% to $35 billion. That excludes hotels and fuel sales. They are now -- obviously, we've exited the hotels business, and fuel, we've become a commissioned agent. EBIT on a retail calendar basis was down 8.1% due to the anticipated lower fuel volumes and corporate costs associated with the demerger.

The most pleasing aspect of results certainly for me was the fact that supermarkets returned to profit growth for the first time in 3 years. We've also seen 47 years of -- 47 years -- 47 quarters of comp growth in supermarket sales.

When we demerged, we talked about the investment highlights around Coles, and we spoke to how the company had strong cash generation, an attractive dividend payout ratio and a robust balance sheet. And it is good to be able to report that we've delivered on those.

Operating cash flow was $2.2 billion and a cash realization ratio of 110%. Net CapEx was $770 million on an accrued basis. Our net debt improved to $520 million providing significant flexibility for long-term growth.

I'm pleased to report that Coles will pay its inaugural dividend in September after the Board determined a totally fully franked dividend of $0.355 per share, comprising a final dividend of $0.24 and a special dividend of $0.115.

The special dividend covers the period from the demerger from Wesfarmers. You'll recall they paid the first 5 months dividend, plus the 53rd week in the year. The final dividend covers the second half of the year and represents a payout ratio of 80.1%. The overall dividend payout ratio is 81.7%.

None of these financial results would have been possible without the support of our 113,000 team members, and we continue to focus on making Coles a great place to work. It was great to see that in our culture survey that improved by 3 percentage points, and we are embedding safety into the DNA of Coles where our TRIFR has reduced by 20% during the course of the year which is an outstanding result.

Moving on to Slide 4. Since the demerger, we've announced several value-creating deals and partnerships with Ocado, Witron, Optus and SAP and a new alliance agreement with Viva designed to grow fuel volumes in the medium term. We've entered into a joint venture with AVC in relation to our hotel and retail business in Queensland that will enable us to focus on liquor retailing and give us more growth opportunities in that state as they invest in hotels up there.

Critical to our success is our commitment to the communities in which we operate, and I'm delighted to report that $115 million has gone to our community partners, including SecondBite, Redkite, FightMND and the Coles Nurture Fund.

Finally, it was only 2 months ago when we presented our refreshed strategy to the market to sustainably feed all Australians to help them lead healthier, happier lives.

If you turn to Slide 5, where we rearticulate our purpose and vision and the 3 key strategies which I'm sure you're all familiar with.

Slide 6, the differentiators. These are the things that we're really working hard on and the things that we think we will win at. And those include winning in online food and drinks, and that's the move towards Ocado in the next few years. To be a great value Own Brand powerhouse and destination for health, and we've made significant progress on those this year. And we've also talked about achieving a long-term strategic advantage through technology partnerships to reduce our cost of doing business. We've also laid claim to being Australia's most sustainable supermarket, and you will have seen the results this week of some hard work to establish 3 solar power plants in New South Wales. And we believe we can only achieve this strategy by better team engagement and delivering with pace of execution.

If you turn to Page 7 which is inspiring customers through better value food and drink solutions. Just some key highlights through the year. Obviously, we've had a lot of successful marketing campaigns including collectibles. All of our campaigns, Little Shop, Fresh Stikeez, the Fresh Containers all have positive customer engagement and helped to drive sales growth.

With regard to Own Brand, we launched 1,200 new products, 90 winning awards, and we exited the year at 30% penetration. The Own Brand business is growing twice as fast as the rest of the business.

We know our customers want healthier options. We talked about this at the Investor Day, and we've moved -- removed 110 tonnes of salt and 150 tonnes of sugar from our Own Brand products during the year, including soft drinks, while still growing sales.

Our convenience business continues to grow. It's our fastest-growing category within supermarkets, and we added 200 products during the year. And now we're in the process of rolling out a convenience section to our best-performing stores.

The online business has been terrifically successful this year. Not only has it achieved 30% sales growth to $1.1 billion, we've also achieved the first profit number in Coles' 20-year history which is a significant milestone and the team's done an outstanding job there.

If you look at the business, it's now 650 vans, and we've got Click&Collect almost complete rollout through the estate. And that business is growing significantly and obviously is a more profitable outlet for us than home delivery.

Another element of Inspire Customers is our export business. And our export sales, predominantly meat, grew 36% during the year, and we're investing in growing that team to make that a significantly bigger business going forward.

With regards to liquor, we launched 64 new Exclusive Liquor Brand lines and won 189 medals and awards in the process. And the rollout of First Choice Liquor Market continues to be successful.

If you move on to Slide 8, Smarter Selling. We talked about the cost pressures in the business and the need to work more efficiently and faster. Ian Bowring has joined the business and he is leading this program. Many initiatives are underway. In-store wearable technology and deli easy ordering are improving stock loss, availability and efficiency.

From a logistics point of view, we've established transport hubs in Western Australia and Victoria which have increased backhaul by around 60%. We continue to optimize our store network with tailored formats and 4 new stores in growth corridors. And we've begun implementing cost-out initiatives towards our Smarter Selling with the announced 450 roles in our Store Support Centre.

So moving on to Winning Together, which is Slide 9. Obviously, we're a very important part of the Australian landscape and recognize that we have a big job to do for the communities we serve.

So as highlighted here, we're committed to driving sustainability, and we talked about the solar plants this week that will reduce our energy bills going forward. We've got 4,100 indigenous team members, which makes us the largest private sector employer of indigenous people. And we have committed to increasing that number to 5,500 by 2023. And as we've mentioned, we've made sure that $115 million has gone to our charity partners which included Drought Relief.

We've expanded our Quiet Hour to 261 stores now to help those customers with autism. And we're reducing environmental impacts with the completion of LED lighting to all supermarkets and also increasing the number of supermarkets on solar power. We have 30 to date and plan to do another 38 in the coming year.

If you move to Slide 10, we talked about the measures of success on Investor Day, and this is the strategy tracker. As you can see, we've made some inroads on most of the measures there. We're at the start of the 4-year transformation program. I describe it as a solid start, but we've got a long way to go. And as we've said before, we're facing significant headwinds in terms of costs, and we are entering the most competitive period in Coles' history.

I'll now hand over to Leah to take you through the group financials. Leah?

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Leah Weckert, Coles Group Limited - CFO [3]

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Thank you, Steven, and good morning, everyone. I'm now on Slide 12.

On a statutory basis, sales revenue declined by 1.9%, and EBIT, which includes the significant items, declined by 0.9%.

As we said at the half-year results, Coles has adopted a retail calendar for statutory reporting purposes. To support the understanding of underlying business performance, our financial performance for the rest of this presentation will be presented on a retail calendar basis for the group and segments, and excludes the significant items associated with our supply chain modernization project of $146 million, the $137 million gain from the New Alliance agreement with Viva Energy, and the $133 million net gain associated with the establishment of the Queensland Venue Co joint venture.

So moving on to the results on a retail calendar basis. Sales revenue increased by 3.1% to $35 billion, excluding fuel sales and hotels, which are not part of the business going forward. Pre-significant items, retail EBIT declined by 8.1% to $1.325 billion as a result of lower Express fuel volumes and corporate costs associated within a standalone ASX company.

The completeness, I'll also cover off, that the 53 week EBIT number, inclusive of hotels, is $1.363 billion. And I have to say we're all looking forward to this being a little less complex next year.

I'd also like to mention at this point that you will see in the full financial statements an effective tax rate of 25.8%. The statutory effective tax rate includes the adjustments relating to the establishment of QVC and the impacts associated with the formation of an income tax consolidated group.

Excluding these factors, the normalized effective tax rate is 30.8% which is broadly consistent with previous years.

Turning now to Slide 13. As you can see, the primary driver of the group EBIT decline was expressed, which experienced a 69% full-in earnings for the year driven by lower fuel volumes which were down 13% for the year. Supermarket's EBIT was the highlight, increasing by 2.2%. And as Steven mentioned, this is the first full year EBIT growth since FY '16 and is a great result, particularly in light of the cost headwinds such as the implementation of the supermarket's EVA. Liquor also performed well with EBIT growing by 8.4%, excluding hotels. The $50 million EBIT for Express is in line with what we previously communicated about the New Alliance agreement impacts for this year.

The Other category includes the corporate costs, Coles' 50% share of flybuys' nonprofit, and the gains and losses from the property portfolio. And as you can see on the slide, the FY '19 reported net cost of $28 million.

Coles' share of net profits for its 50% equity interest in flybuys was $5 million profit for the year. There was a net gain from property-related activity of $7 million for the full year, and the remainder of the Other segment is corporate costs.

As previously discussed, Coles expected there to be a number of one-off costs as a result of the demerger. These were estimated to be $10 million to $15 million for the second half. Pleasingly, the incurred one-off costs have been lower than expected at around $7 million, taking one-off demerger costs for the year to $17 million.

Corporate costs have taken time to reach a full run rate, and we reiterate that $66 million per annum is a reasonable estimate of corporate overheads going forward.

I'll now turn to Slide 14. As we have done in the past, this slide shows statutory cash flows normalized for demerger-related items to make it more useful for investors when trying to understand the cash generation of the underlying business.

Operating cash flow, excluding interest, tax and demerger-related items, was $2.2 billion, a reduction of $216 million compared to FY '18 primarily driven by lower Express EBIT and higher corporate costs. Importantly, the cash realization ratio was strong at 110%, and we continue to target greater than 100% cash realization on the same calculation basis in future years.

The movement in working capital was favorable by $81 million with reductions in inventories being the main driver. The movement in provisions and other was primarily a result of higher employee provisions, unredeemed gift cards and the recognition of the Smarter Selling restructuring provision of $19 million which we disclosed at the investor strategy day.

I'll now take you through capital expenditure on Slide 15. Net capital expenditure on an accrued basis increased by $209 million to $770 million, in line with previous guidance of $700 million to $800 million. The biggest increase in CapEx was in the areas of store renewals and efficiency initiatives.

In the store renewals category, we completed 51 renewals in supermarkets, 52 renewals in liquor, and there were 259 Coles Express renewals which was primarily the food-to-go rollout.

In the efficiency category, the increase was primarily driven by initial payments to Witron in relation to our supply chain modernization program.

Turning now to Slide 16 and the balance sheet. I'm pleased with the cash generation of the business this year and the strength of the balance sheet. As you can see on the slide, as at 30 June, we reported working capital of negative $115 million, capital employed of $4.5 billion, and net assets of $3.4 billion.

In terms of our debt position, at the time of the demerger, Coles drew down $2 billion from the initial $4 billion committed debt facilities. Since then, part of this debt has been repaid to take gross debt to $1.46 billion at 30 June. The repayment of the debt is as a result of the strong cash generation during the period together with the proceeds received from the New Alliance agreement with Viva Energy and the sale of the hotel portfolio to AVC.

Net debt at 30 June 2019, was $0.5 billion, and the leverage ratio was 0.5x.

We have chosen to maintain balance sheet flexibility in the short term. We have paid down all debt except the term debt that would require us canceling facilities. As a result, we have been building cash on deposit and this cash will be used to pay the dividend we have announced today. The AASB 16 lease accounting standard came into effect in July 2019, and this will impact the balance sheet. I will talk to this shortly.

Turning now to Slide 17 on capital management. We will continue to take a disciplined approach to capital management. As Steven has already mentioned, the Coles Board announced a fully franked total dividend of $0.355 per share for the period from 28th of November 2018 to 30th of June 2019. This comprises of a final dividend of $0.24 per share covering the standard 25-week second half and a special dividend of $0.115 per share covering the stub period from demerger to the start of the second half and the 53rd week. The $0.355 represents a payout ratio for the entire period of 81.7% which is within our guided range. This is comprised of a final dividend payout ratio of 80.1% and a special payout ratio of 85.2%.

In terms of debt facilities, our weighted average drawn debt maturity of 4.6 years provides funding certainty with undrawn facilities of $2.2 billion.

We remain committed to diversify our funding sources over time to reduce financing risk and to exit different markets to ensure the business has access to funding through the cycle to support growth. And we also remain committed to maintaining investment-grade credit metrics.

Finally, as you can see, we have undiscounted lease commitments of $10.6 billion. And this is up from $9.9 billion at the interim as a result of new stores and the renewal of Express site leases as part of the New Alliance agreement. I'll discuss this in the context of AASB 16 lease impacts now on Slide 18.

As we have said in the past, we will apply AASB 16 from the 1st of July 2019 using the modified retrospective approach. We will recognize operating leases on the balance sheet as lease liabilities with a corresponding right of use asset. Straight-line operating lease rental expense will be replaced by straight-line depreciation of the right of use asset and an interest charge on the reducing lease liability balance.

The estimated impact on FY '19 financials had the standard been implemented in FY '19 would have been a positive impact on EBIT of approximately $400 million to $450 million. However, the impact of profit before tax would've been relatively minor given the increase in financing costs. We do not expect there to be an overall impact on cash flow, debt covenants or credit ratings. However, other performance metrics such as EBIT margin and credit metrics will move materially, and we will provide metrics on a consistent basis to assist with comparative analysis.

Moving now to Slide 19. This slide provides a summary of our significant items which we spoke to earlier. The only item that we have not mentioned previously is the tax consolidation adjustment which has impacted our tax expense.

As foreshadowed in the scheme booklet, we have assessed becoming a tax consolidated group as a standalone entity having exited the Wesfarmers tax consolidated group at demerger and we now intend to elect to do so. The $50 million adjustment relates to the reset of the tax cost base as a result of this.

Further, we have now landed on the net gain of $133 million for the AVC joint venture which was provided as a range at the Investor Day.

We won't be covering off the segments in detail today in order to give a good amount of time for Q&A. So I'd now like to hand back to Steven who will cover off the outlook.

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Steven Cain, Coles Group Limited - MD, CEO & Director [4]

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Okay. Thank you, Leah.

So by way of a trading update for the first quarter of FY '20, Little Shop 2 has again resonated with our customers and is driving strong engagement. As envisaged, cycling the comparable sales growth from last year's highly successful Little Shop campaign will be challenging given competitor activity in the market.

In Express, growth of fuel volumes has been encouraging following the more competitive fuel pricing from Viva and the introduction of the Little Shop 2 campaign. However, it will take time to build volumes to target levels, and as a result, Coles expects earnings growth under the New Alliance Agreement in Coles Express to remain subdued during FY '20.

We also made a number of statements relating to CapEx, renewals, new stores and formats during Investor Day, and these remain unchanged for FY '20.

The Smarter Selling initiatives in FY '20 are anticipated to deliver annualized benefits in excess of $150 million.

Thank you for listening.

I'll now open up the line for Q&A. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Andrew McLennan of Goldman Sachs.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [2]

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Just a quick one around the cost-out. It sounds like there's been a pretty aggressive execution of that cost-out, $150 million in the first year. Can you just speak to what's driving that? You mentioned the 450 staff reductions. I'm just wondering what else is expected to come through over this -- over the financial year, please.

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Leah Weckert, Coles Group Limited - CFO [3]

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Yes. Thanks, Andrew. So obviously, the 450 roles coming out of SSC is a key initiative for the corporate center. There's also quite a bit of detail that's being billed off in terms of initiatives in our stores and in logistics. I think pleasingly, we're starting to see some of the benefits come through of the organizational change that brought DCs and stores in under a single point of leadership under Matt. So in the next couple of months, we'll be rolling out our end-to-end roster integration which will look at how we flow stock from DCs into transport in-stores, and that we'll look at actually taking quite a bit of activity out of peak times which will help us to reduce costs, and reducing deliveries to slow-moving ambient while increasing deliveries for the fresh, fast-moving line. So we'll get a dual benefit there of better availability, better freshness but also cost-reduction.

The -- things like the transport integration that we've spoken about in logistics in VIC and WA, we'll start to see that roll out to other states. So South Australia is going to be the next cab off the rank doing that. And we've also got some DC labor planning tools that we'll be rolling out to DCs. And in in-stores, there's quite a big focus on loss. So we've got some tools around using advanced analytics to get much more optimization around markdowns and also some profit protection initiatives going in to prevent stock loss.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [4]

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Okay. That sounds pretty thorough. It equates to around 40 basis points in sales, so pretty substantial reduction in -- or impact to the cost line. I'm just wondering -- I know there was a big focus at the strategy day around what's gross versus net, et cetera. I guess from my perspective, I'd be more interested to know just how you anticipate your comp store sales momentum to play through. Obviously, the first quarter's going to be a bit tough, but to get an understanding what kind of deleveraging you'd be experiencing. Maybe if you could just talk to the early indications of your new format store refurb and how you expect that rollout to go.

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Steven Cain, Coles Group Limited - MD, CEO & Director [5]

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Okay. Andrew, I think the measure we're looking at from a sales perspective or the last clean measure we had was really the exit at Q4. So that's the last I can offer you on that front. As we've said, it will be a challenging quarter for us as expected.

As far as the format renewals is going, I think we've highlighted in this presentation that the First Choice Liquor Market's going well. Certainly, all of the things that we talked about at Investor Day, which is the Format C in Ardeer and the Format A at Pagewood. They're traveling well. And we're very pleased with the profitability of the new Coles Local as well.

So as we roll those out during the year, we would expect to either see either sales improvement or reduction in costs. And I think we've flagged that there are going to be 75 renewals or so during the year. They will be weighted towards the Format C.

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Leah Weckert, Coles Group Limited - CFO [6]

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Maybe I can just cover off the issue around the gross or net. So there's 150 -- the in-excess of $150 million is a gross number, so that will be used to offset cost headwinds and also because a lot of these initiatives, as you rightly identified, are sort of only just getting up and going. That's looking at an annualized benefit of that. So we'll only start to see the benefits for most of those initiatives start to roll through in the latter part of the year.

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Operator [7]

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Our next question is from Shaun Cousins of JPMorgan.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [8]

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Maybe just a question on cash flow. Leah, you commented around confidence of keeping cash conversion above 100%. You did 110% in the period. How much benefit did you get from unwinding inventory at the end of June? There was a lot of discussion in the industry that Coles effectively took on less stock at the back end of the year. Can you confirm if that happened, and hence, how sustainable is the 110%? Or should we sort of drift back towards the 100% in the future, please?

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Leah Weckert, Coles Group Limited - CFO [9]

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So I mean we've done quite a bit of modeling around the sustainably of the 110%, and we have good amount of confidence on that. There's certainly some benefit from the unwind of inventory, and actually, I've identified it when I talked through the shift in the working capital. A decent chunk of that -- the primary driver of that was the inventory.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [10]

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And so pardon me, but do you think that means that 110% is sustainable or is it more just above 100% is sustainable?

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Leah Weckert, Coles Group Limited - CFO [11]

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We think above 100% is sustainable.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [12]

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Perfect. Okay, and then maybe just secondly, just in regard to sort of convenience. The comment was made around a bit more of a this year -- fiscal '20 being a subdued year. What's the prospect of profit being achieved in this year given that volumes continue to decline? While they're showing an improving trend, the comp decline of [8 9 percent] in the fourth quarter is still concerning. When do you think you'll start to get to flat volumes, let alone the $70 million? And can you actually generate a positive EBIT outcome in fiscal '20, please?

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Steven Cain, Coles Group Limited - MD, CEO & Director [13]

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Hi, Shaun. Yes, look, what we noticed, as we went through Q4, was that fuel volumes was stabilizing towards the end of the quarter. That's not year-on-year, by the way, but that's sort of week-on-week. So the decline has halted. And then as we mentioned in the outlook here, what we have seen is a fairly significant increase in fuel volumes as a result of some recent pricing -- or more recent pricing activity by Viva and the introduction of Little Shop 2 into Coles Express.

What we've said from an outlook perspective, and I think you'll sort of recognize that we broadly made $50 million or so in the first half and more or less flat in the second half of the year. What we've said is that profit growth, I think, will be challenging in that business. So we're not issuing a profit forecast as such but that's what we're seeing.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [14]

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I mean, sorry, but will profit be able to be achieved -- sorry, pardon me, that's my question. Do you think profit at all, let alone growth? I'm just curious about...

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Steven Cain, Coles Group Limited - MD, CEO & Director [15]

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Well, I'm just sort of articulating what was achieved in the second half which was broadly flat. What we've said is that profit growth will be challenging, so I'll leave you to read into that one.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [16]

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Sorry, on the second half, that is. Profit growth on the second half-type number under the new structure?

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Steven Cain, Coles Group Limited - MD, CEO & Director [17]

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Yes, I think when we -- I think at the half year, we issued a forecast for the full year. We'd sort of said that in the first half, we were making around about $50 million and that we expected that to be the full year outcome, and that's what's been delivered. So that was the run rate, more or less, going into F '20. And then what we've said as part of the outlook is that profit growth will be challenging in FY '20.

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Operator [18]

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Our next question is from David Errington of Merrill Lynch.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [19]

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I have 2 questions. First question, can you elaborate on the cost savings? Because as I think you highlighted, cost savings was -- is being a good performance in this result. The actual improvement in logistics, can you talk about what this -- you highlight transport hubs in Victoria and WA, and I know that you changed the provider -- you changed providers. I think you went to Toll. But how much of a price going forward in earnings can there be through cost savings in logistics? And can you actually highlight what that actually means when you said your backhaul increased by 57% to 60%, respectively, in WA and Victoria? Because that could be -- that seems to me to be quite significant. Can you elaborate on what the price is to Coles in improved logistics, please, and as a source of future profit growth?

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Steven Cain, Coles Group Limited - MD, CEO & Director [20]

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Yes. Hi, David. Yes, look, I don't think we'll be going into details by initiative, but in relative terms we do relatively little backhaul. And obviously, it'd be ideal if every truck that sort of came back to Coles was full. So we see that as significant. There's obviously a whole raft of initiatives lined up for supply chain as we enter the world of Witron and Ocado. So from our point of view, I think as we've already said, we see supply chain as one of the big areas for improvements for Coles. So we're fairly optimistic that we'll be able to get the cost of doing business down over time in that area.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [21]

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So it comes through your GP line, does it? Those logistics savings is supportive of your GP?

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Steven Cain, Coles Group Limited - MD, CEO & Director [22]

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Yes, that's one of the factors. I wouldn't say it was the primary factor, though. I mean the primary factor is really around what we've been doing on range reviews and promotional activity and Own Brand.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [23]

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Right, okay. My second question, Steve, is a general one is that my observation is that in the last 12, 18 months, the supermarket industry in Australia has become, for customer engagement, extremely gimmicky. I mean, please, I mean no disrespect to that because -- but Little Shopper, Stikeez, Ooshies. I think Woolworths are going to go down the path of Discovery Garden. I think that was announced in Home & Garden (sic) [House & Garden] I was reading the other day. That looks like a big one in the next month.

It looks like supermarkets are just going down the path of who's got the best plastic toy to give to customers. What's your view on this and where this is going? Because what it may as you say, this first quarter, you're up against a 5% like-for-like. It's going to be pretty tough to do a positive comp. I mean you've pretty well highlighted that. Is it really adding value to your business going down this path or -- because the brand customer aware -- or the brand connection, if you like, you call it customer engagement. But is it really customer engagement, who's got the best toy? Because they come in for a month and then they don't come back. I mean I'm really interested to hear what your view is on this trend that we're seeing in Australia in the last 12 months and whether this is actually adding value to the Australian supermarket industry.

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Steven Cain, Coles Group Limited - MD, CEO & Director [24]

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Yes, look, I probably share some of that sentiment that there are a lot of collector schemes going on in the marketplace, and I think it's fair to say that what we're seeing is a neutralization of their impact. They are, however, successful and they do generate sales and some profit.

What we've seen over the course of time in supermarketing, I grew up in the world of Green Shield Stamps, pots and pans and everything being done, and then they went away as other things emerged. Our long-term plan is not to feature collector schemes as highly as they are today. It's not to say we won't have them. Obviously, what we've got in the background is flybuys, and we'd expect that the flybuys' proposition gets better over time. And we'd also expect that our basic value proposition and product range gets better over time and Coles Online gets better over time. But we are where we are with these schemes at the moment. But certainly from my perspective, it does look as though they are beginning to neutralize each other.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [25]

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Are you ready for Discovery Gardens release? Because that looks like it's coming, what, next month. That looks like to be pretty hot one. Are you ready for that? Because it could make it a pretty tough first half if that's a real success for Woolies. What's your response going to be?

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Steven Cain, Coles Group Limited - MD, CEO & Director [26]

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Yes, look, I don't read Home & Garden (sic) [House & Garden], but I did read about the scheme. I'm not going to comment on other people's schemes and how effective they'll be. Obviously, we have plans for the whole year, of which obviously Little Shop 2 was one of them. But I think we have a pretty exciting plan through to Christmas, but I can't comment on how effective other people's schemes will be.

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Operator [27]

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Our next question is from Bryan Raymond of Citigroup.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [28]

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Look, my first question's just around the gross margin profile. You're up 20 basis points in food and 41 basis points in liquor. Just thinking about particularly in the food line, how much of that is being driven by the shift to private label versus, in some cases, substituting price investment for the collectible campaigns? We have seen inflation obviously pickup across the market even excluding -- in between tobacco and fresh certainly had an improving profile. So just interested in how you're thinking about price investment versus other investment like collectibles or is it simply just a private label trend that's driving that gross margin?

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Steven Cain, Coles Group Limited - MD, CEO & Director [29]

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Yes, that's a good question. I think the main thing to sort of look at as far as the inflation numbers are concerned is what's happening in grocery, excluding tobacco and fresh. And there, you can see that we're still continuing to invest in pricing. And that's a combination of the fact that there is a lag between us passing prices on and accepting prices overall. So we're investing in that way. Clearly, we're investing in Own Brand at the entry tier. And then when we look at promotions like Little Shop, obviously, we invest some money in those and obviously suppliers invest the money in those schemes as well.

But overall, I'd say that what's working well for us is Own Brand and a better focus on promotional profitability as well as the range reviews where those are rolling through at pace now. And we are seeing that some customers are moving into the more premium products that are being made available.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [30]

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Okay. And then just into 1Q '20, that inflation profile, how do you see that relative to the fourth quarter if we just take the overall supermarket inflation of plus 1.4 in the fourth quarter? I don't know where fresh inflation's in there, but just interested to see how that -- how you're seeing that over the first few weeks of -- or first half of the first quarter '20. Because I agree with some of the sentiments from other analysts on the call that you're likely to be negative in the first quarter, like for like. But just the one thing that we struggle to predict accurately is the inflation line and whether that's continuing to ratchet up. So perhaps could you give us a bit of color around how you're seeing inflation into that first quarter '20 relative to fourth quarter '19?

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Steven Cain, Coles Group Limited - MD, CEO & Director [31]

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Yes, we'll give you a full update on inflation at the -- when we do the Q1 sales results. I think it's fair to say that inflation is passing through the business. The drought is having a material impact on farmers. And so anything that comes from farms is being impacted, particularly if it comes from those drought-affected areas. So obviously the key ones are produce, meat and bakery, but we are seeing that, that is having a knock-on impact into some grocery areas as well. But as I say, we're doing our best to sort of try and delay price rises as long as we can in the first instance in terms of passing some of these things onto consumers but also in making our own price investments where necessary as well.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [32]

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Right. So just then -- I mean maybe just relative to that 1.4, would you expect deflation to be -- sorry, inflation to be a little higher or lower or broadly the same into the first quarter? Is there a way you could actually give us a direction around that?

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Steven Cain, Coles Group Limited - MD, CEO & Director [33]

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Yes, we're not going to -- I'm not going to get into inflation forecasts for quarters, but we will make sure we give you a full breakdown of what it is when we do report.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [34]

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Okay. And then just on your comment in your release around online becoming profitable from an operating perspective. I'm just interested in that in terms of how you define profitability and whether you assume online sales are incremental or whether you're giving them the overall -- or costs that come through the supply chains, given the fulfillment from stores that you're still doing. So I figured if you could give us more color at how you get to that statement of profitability in online.

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Leah Weckert, Coles Group Limited - CFO [35]

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Yes, Bryan, we do allocate the variable costs-out for online. So they receive all the charges of the room and store and the transport and also -- it's also fully costed in terms of an allocation of corporate costs as well.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [36]

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Okay. So you're essentially assuming that those sales are cannibalizing existing in-store sales when you do that calc implicitly?

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Leah Weckert, Coles Group Limited - CFO [37]

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Well, we find it really important to actually look at the whole of the customer because we find that when customers shop both in-store and online with us, they actually end up spending more overall. So we tend to look at it as customer total profile as opposed to cannibalizing in-store or online. And even if you were to say the cannibalization argument, there's still a fair degree of online sales which are truly incremental for the business because we've got quite a few of B2B customers that come through where we otherwise wouldn't have that customer in our stores.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [38]

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Great. Okay. And then just final one just on the balance sheet. You guys have come in on a reasonably low net debt level, and your net debt to EBITDA is now looking pretty attractive, 4.5x. Where do you see that through the cycle? Do you expect that to be maintained that level into '20? And at what point do the capital returns come on the table for you guys?

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Leah Weckert, Coles Group Limited - CFO [39]

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Yes. So we don't have a target net debt that we're working to other than that we want to maintain investment-grade credit metrics. And we also would note that it's pre the dividend at the moment. So I agree with you. We are in good shape at the moment, but I think we will need to have some discussions with the Board in the near term about how we -- or in the longer term around how we actually structure it longer term depending on where we go.

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Operator [40]

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(Operator Instructions) Our next question is from Ben Gilbert of UBS Investment Bank.

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Ben Gilbert, UBS Investment Bank, Research Division - Executive Director and Analyst [41]

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Just the first question for me just around your ability to grow earnings within the grocery division for this year. Understanding that the cost-out is going to be back-end-weighted and obviously leading to some softer probably likely negative comps for the first quarter. Do you think it's realistic for you to be able to still grow EBIT in the core food business the first half into the full year?

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Steven Cain, Coles Group Limited - MD, CEO & Director [42]

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Yes, we're not issuing a profit forecast today, Ben, just -- the outlook is about as far as we'd like it to go. Obviously, there's a lot of things that we don't know about in the next 9 months. There are a lot of things we do know about, but what we're trying to do is look at the things that are within our control. And we think we've got a good consumer plan for the year ahead, and we think we've got a good cost plan for the year ahead. But we're not getting into profit forecasts by division.

I will hold to the statement I made on Investor Day, which is at a group level, I'd be disappointed if we're not in group profit growth by '21. And obviously the trajectory -- if you look closely at the trajectory of the supermarkets business, it's been improving through the both half despite some significant cost headwinds which were the EBA and the transition to -- or transition away from single-use plastic bags.

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Ben Gilbert, UBS Investment Bank, Research Division - Executive Director and Analyst [43]

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That's helpful. And just to your point, just around that how we should think about the corporate cost line, that $66 million for this year, that's obviously gross. But do you envisage -- and again, I'm sorry, I might be going down the path of specific commentary again, but sort of property profits or other things coming back to offset that? Or should we be thinking more of a $66 million-type cost at that other line through the divisionals?

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Leah Weckert, Coles Group Limited - CFO [44]

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Yes. I mean the $66 million is the gross corporate costs. Obviously, there will be flybuys contribution in there, so that's likely to be relatively small in terms of moving the number. The property one, to be very honest, moves around a lot. And it's very dependent on where we are in the market, so it's difficult for me to give you any guidance on that one, to be honest.

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Operator [45]

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Our next question is from Vanessa Jeffriess of Macquarie.

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Vanessa Jeffriess, Macquarie Research - Equity Research Associate [46]

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I am wondering if could you talk to us a bit more about the performance of those renewals or the new formats? You said the mid to high single digits was -- you would consider that successful. What proportion are you currently meeting in that target?

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Steven Cain, Coles Group Limited - MD, CEO & Director [47]

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Well, of the ones we were just talking about then, we've only got 2 format Cs at the moment. We've got a couple of -- more of the format As. We just relaunched The Glen this week very successfully. It's too early to sort of give out any numbers on that, but it was a successful relaunch. And then at the current time we've only got 1 local.

But all of those are performing well at the moment, and obviously the plan is to roll them out during this financial year. And as Leah has already articulated, we did about 50 last year and the plan is to ramp that up to about 75 in the current financial year as well as roll out the convenience offer as a module to more than 100 stores.

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Vanessa Jeffriess, Macquarie Research - Equity Research Associate [48]

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Yes. And is your plan to kind of use the different formats as a way to pass through price increases?

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Steven Cain, Coles Group Limited - MD, CEO & Director [49]

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No.

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Operator [50]

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Our next question is from Phillip Kimber of Evans & Partners.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [51]

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I just had a question. Just on the outlook for interest costs, I think it was about $35 million in the second half on a pretty low net debt number. Obviously, you've got working capital debt that moves around a lot. How should we think about going forward? Because you've obviously got a big dividend payment coming through and there wasn't one in the second half. So are you sort of annualizing that second half and then adding a beat for the dividend the best way to think about your interest cost in FY '20?

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Leah Weckert, Coles Group Limited - CFO [52]

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Yes, I mean I would be working through an interest rate of around $50 million, which trends for the interest costs for the year.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [53]

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$50 million in total for the year?

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Leah Weckert, Coles Group Limited - CFO [54]

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Yes.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [55]

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Okay, for interest. Great. And then my other question was -- it sort of got asked about a little bit before, but in terms of the gross profit margins in supermarkets, the GP is up about 20 basis points. I mean where is stock loss profit there and where could it get to? Can you sort of provide a bit of color around the opportunity there?

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Steven Cain, Coles Group Limited - MD, CEO & Director [56]

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Yes, we're probably not going to get into that level of detail today. Clearly, stock loss is a big opportunity, and we're doing a lot of work with technology in that space. And I think it's been reported from time to time, where one of the key focuses is the self-serve checkouts. So that's getting some work. We're also working on rolling out automated ordering in the remaining fresh areas as well. And again, that will help reduce waste in the system. So there's a whole raft of -- like in supply chain, there's a whole raft of measures that we're looking at to sort of driving down waste and stock loss and markdowns and so on.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [57]

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But we should expect GP margins to continue to improve from here?

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Steven Cain, Coles Group Limited - MD, CEO & Director [58]

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Yes. Again, we've never been a forecaster of GP because, obviously, to some extent it depends on external conditions. What we're trying to do within our control is to improve the margin mix. Obviously, that's one of the things that the buying team is endeavoring to do through their range reviews and so on. And obviously some of the Own Brand areas are high-margin. And we're trying to reduce the number of loss-making promotions or unprofitable formations that we're doing as well. So I think we'll do our best to improve margins, but to some extent, it depends on the pricing in the industry.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [59]

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Got it. And just clarify on Leah's answer of $50 million. Does that include -- is that all up or do we need to add the discount rate adjustment to that $50 million?

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Leah Weckert, Coles Group Limited - CFO [60]

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It's all up.

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Operator [61]

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Our next question is from Rod Sleath of Rimor Equity Research.

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Rod Sleath, Rimor Equity Research Pty Ltd - Equity Analyst [62]

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Just 2 questions. The first, I just wanted to perhaps expand on the technology announcement that have come out, in particular -- not so much Ocado or Witron, but you've announced a strategic partnership with SAP, but also with Microsoft and with Accenture. Is -- am I correct in understanding that effectively Accenture is going to be handling or predominantly handling the rollout of the SAP and Microsoft modules that you're going to be using? I guess that's the first part of the question.

And secondly, we also understand that your legacy ERP system is an Oracle system. So it looks a little complicated, and there's an awful lot going on in your IT department. Perhaps you can sort of expand on the road map for how these modules -- or what the time frame for various modules is to be rolled out, and how important are they enablers for future efficiency gains. And perhaps for the integration of Witron and Ocado strategic relationships later on.

And then finally on the same topic, are you ultimately looking at replacing that legacy Oracle system and simplifying perhaps your IT suppliers?

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Steven Cain, Coles Group Limited - MD, CEO & Director [63]

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Thanks for that one. That's a long question and -- or a number of questions, I guess. I think to start with there is a lot going on in the IT department, and we have a terrific team of IT professionals here. We have more than 1,000 people in our IT department, so they end up doing a lot of the work quite clearly. What we're looking for in all of the partnerships that we're embarking on is to try and find the best people in the world to partner with so that we're not reinventing the wheel. And in things like SAP, Optus and so on, we've tried to pick the best system that is most suitable to our needs.

Accenture is helping with the implementation of some of those programs. We believe that all of them will help drive efficiency in our business. Clearly, we're in the process of migrating. Like everybody, we're in that sort of process of migrating to the cloud. And in migrating to the cloud, you sort of change your economic model from being the traditional buying and depreciating to operating costs and so on.

So there's a lot of things to think about as we transition over time. Clearly, there will be a new ERP system at some point, but it's not -- it's not imminent as we work on those other things and then sort of obviously the integration of Ocado and Witron in due course.

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Rod Sleath, Rimor Equity Research Pty Ltd - Equity Analyst [64]

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Sure, okay. And just with regard to the time frame of rollout, am I correct to understand that really the first announcement, which was sort of the SAP HR, finance and procurement modules, that's the priority initially to get that rolled out over perhaps Microsoft ERP within your convenience?

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Steven Cain, Coles Group Limited - MD, CEO & Director [65]

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There's a few things going on at the same time. So we are currently implementing the HR system, and we are currently implementing the Ariba procurement system. Leah, do you have any other...

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Leah Weckert, Coles Group Limited - CFO [66]

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So the big ones are the SuccessFactors and Ariba. So Ariba, the first phases of that have already gone live, and we've got a next release of that happening later on this half. And then SuccessFactors is in the initial stages of the implementation with some first phases of that going live in second half.

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Rod Sleath, Rimor Equity Research Pty Ltd - Equity Analyst [67]

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Sure, fantastic. All right. Just one more thing on that, sorry, if I can. Just with regards to the HR system which is rolling out at the moment, I remember when Woolworths rolled out their HR module with SAP, they went from a system which was basically operating largely on spreadsheets and faxes even at the time. And there was an enormous efficiency gain that happened because of that. Are you going from that level or are you going from something that is absolutely more modern than what Woolworths were using at the time?

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Leah Weckert, Coles Group Limited - CFO [68]

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I mean, we were already on a SAP HR system, so the level of step-change for us is not as significant as going from Excel and faxes. I mean we are actually doing this because we believe there are efficiency benefits from it. But it doesn't sound like we're going to get the same step-up that you're describing there.

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Rod Sleath, Rimor Equity Research Pty Ltd - Equity Analyst [69]

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Sure, that's great. The other question I was going to ask was actually just about the Own Brand penetration, and it's really just a clarification question so it should be quick. But in the press release, you said the Own Brand penetration's reaching -- reached 30% over the year. Can I just clarify what you mean by penetration? Does that mean that 30% of products you have on offer there is an Own Brand or something else available? I presume it doesn't mean that 30% of your sales are Own Brand.

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Steven Cain, Coles Group Limited - MD, CEO & Director [70]

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Yes, it does mean 30% of our sales are Own Brand, yes. Yes.

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Rod Sleath, Rimor Equity Research Pty Ltd - Equity Analyst [71]

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Oh, it does? Okay. And given a reasonable proportion of your sales of fruit and veg were presumably down compared with Own Brand, the actual proportion of ambient is presumably considerably higher than that 30%?

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Steven Cain, Coles Group Limited - MD, CEO & Director [72]

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It's actually the other way around. We have seen that if there's no brand on there, then it's a Coles product that we take accountability for. So the penetration in grocery is lower but improving.

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Operator [73]

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Our next question is from Johannes Faul of Morningstar.

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Johannes Faul, Morningstar Inc., Research Division - Equity Analyst [74]

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I had a question in regards to online being profitable now. Is there anything you can point out towards what has moved that into being a profitable channel now? Is it purely scale or is it the mix of Click&Collect versus delivery now that -- well, you still have Click&Collect.

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Steven Cain, Coles Group Limited - MD, CEO & Director [75]

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Yes, it's a combination of all of those factors. The scale clearly helps. We've also implemented a lot of more Click&Collect locations, and that's more profitable than home delivery. And then there's been a number of productivity initiatives in the business as well. So it's a combination of a number of items that have led to that breaking into profitability. Still a long way to go, I might add. So that's a start, not the end.

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Johannes Faul, Morningstar Inc., Research Division - Equity Analyst [76]

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Okay. And I guess a way to think about it as that channel scales that you -- just growth was 30% as they continue that double digits. And as scale increases, should we think about that business becoming more profitable?

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Steven Cain, Coles Group Limited - MD, CEO & Director [77]

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Well, that's certainly the plan, yes.

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Johannes Faul, Morningstar Inc., Research Division - Equity Analyst [78]

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Okay, okay. And then just lastly, maybe just on the -- the EBA was called out a few times as the headwind on the EBIT margin of supermarket. Is there any way you could quantify that for us in terms of basis points or perhaps absolute figure?

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Steven Cain, Coles Group Limited - MD, CEO & Director [79]

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On the cost headwinds?

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Leah Weckert, Coles Group Limited - CFO [80]

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On the EBA.

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Steven Cain, Coles Group Limited - MD, CEO & Director [81]

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On the EBA that was implemented this year? Yes -- no, we've not quantified that, but obviously it's in the result as is the move to plastic bags -- or the plastic bag changes as is the change in mix from -- to online.

So as we said before, we're pretty pleased with that profit growth in supermarkets this year given the headwinds that are there as well as the sort of natural inflationary increases in utilities and so on.

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Operator [82]

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Our next question is from [Ben Wang] of Vanguard Australia.

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Unidentified Analyst, [83]

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I think my question was answered earlier, just on the percentage of private label versus non-private label. But could you maybe just comment on the -- say, the average GPM of a private label versus a non-private label, and how should I think about profitability between the 2?

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Steven Cain, Coles Group Limited - MD, CEO & Director [84]

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So I'll comment on the profitability piece. So there's no easy answer to this one, which is some private labels are low margin because they're at the entry price point and some private labels are significantly better margin because they're at the premium and higher quality. Obviously, what we're trying to do is as the consumer sort of goes towards value or convenience just to make sure we're catering for both. And so what we're trying to do is manage the overall margin mix in the store, not just on private label, and to make sure that as we've said already that we're minimizing waste and markdowns in the process.

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Unidentified Analyst, [85]

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Okay. And how shall I do that for the non-private layout -- non-private label products?

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Steven Cain, Coles Group Limited - MD, CEO & Director [86]

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What, in terms of what the margins are?

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Unidentified Analyst, [87]

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Yes.

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Steven Cain, Coles Group Limited - MD, CEO & Director [88]

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Well, look, as I mentioned before, we're not forecasting gross margins today. But what we are trying to do is to manage gross margins that's within our control. And gross margin is made up of 2 things. Things that you control in terms of mix and product development, but it's also things like waste and markdown. And it's also things like what the prevailing prices are like in the marketplace.

And as we've said already, there's prices going up through the drought and then there's price -- increased price competitiveness in areas like grocery. So it's difficult to answer that question as probably as well as you would like, but that's about as much as I can say today.

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Operator [89]

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Mr. Cain, there are no further questions. Would you like to make some closing comments?

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Steven Cain, Coles Group Limited - MD, CEO & Director [90]

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Yes. Just thanks for your time, everybody. And no doubt the IR team will be following up with you over the course of the coming days. Thank you.

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Operator [91]

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Thank you. That concludes today's call. You may now disconnect your lines.