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The real winner from Coles Group’s profit upgrade

Brendon Lau
is it a buy

If you are wondering why the Coles Group Ltd (ASX: COL) share price fell after posting a profit upgrade while its ex-mothership Wesfarmers Ltd (ASX: WES) rallied, there could be a method to the madness.

Shares in the supermarket chain returned all its gains in early trade on Thursday to end 0.1% lower at $16.63 while the Wesfarmers share price jumped 1.4% to $45.55.

In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index added 1% in value yesterday.

Why Coles’ shares dipped

Some might think that the risk-on sentiment on global markets may have contributed to the weakness in Coles given that stocks like that are seen as defensive, but that won’t explain the 0.8% rally in the Woolworths Group Ltd (ASX: WOW) share price.

The thing is, Coles’ better than expected performance is only a little better than what the market was expecting and it won’t quell concerns that the stock has run ahead of fundamentals. The Coles share price increased by a very pleasing 36% over the past year.

Another reason is that the market may be anticipating a large amount of Coles stock to come onto the market from Wesfarmers.

Sell down coming?

The conglomerate divested Coles into a November 2018 but still holds a 15% stake in the supermarket.

There’s speculation that Wesfarmers may be looking to sell part of its holdings to capitalise on Coles’ strong share price run.

The timing of Coles’ bullish update is feeding the conspiracy theorists, according to the Australian Financial Review.

Some are questioning why the supermarket is issuing the good news so close to its results and if the announcement was even needed given that the underlying earnings before interest and tax (EBIT) wasn’t much above consensus.

Eager seller

Wesfarmers needs to maintain at least a 9% holding in Coles to keep its board seat, but that still leaves it with a lot of stock it can sell.

The sale is likely to be an off-market trade to minimise any direct pressure on the Coles share price, but that won’t mean the stock won’t fall.

To get the “cross” over the line, it would be my guess that Wesfarmers will need to offer up its stake at a discount to the current share price unless it finds an eager buyer. But since no one could consider Coles a bargain, I think selling stock at or above the market price would be tough.

If the stock is offered at a discount, it is more likely than not that Coles’ share price will dip towards the offered price (as this typically happens). Wesfarmers, on the other hand, will be smiling all the way to the bank.

It’s easy to see who’s on the winning side of the Coles’ upgrade.

The post The real winner from Coles Group’s profit upgrade appeared first on Motley Fool Australia.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. Connect with him on Twitter @brenlau.

The Motley Fool Australia owns shares of Wesfarmers Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. 2020