Coles and Viva Energy play high stakes game of bluff

The high-stakes game of bluff between the Coles supermarket chain and Viva Energy over wholesale petrol prices looks very much like two kids fighting in a school yard.

Neither side wants to admit they are wrong. But as the stoush drags on the bloody noses get worse. In this case shareholders of Coles and Viva are paying the price for the failure of senior executives to reach a compromise.

Coles now has the most expensive fuel in Australia at a time when the rise in global oil prices has pushed fuel at the bowser to a four-year high. This is not the sort of problem that new managing director of Coles, Steven Cain, needs as he approaches the demerger of the company from Wesfarmers.

Chanticleer suspects Viva might blink first because the prospectus it released in July with its initial public offering promised earnings growth. That is not going to happen while it is in stand-off with Coles over fuel.

The board of Viva met in Perth on Monday. One assumes the chairman Robert Hill and CEO Scott Wyatt led the discussion on what can be done to resolve the burning issue with its single biggest customer.

After all, anyone who bought Viva shares in the IPO could well be asking the obvious question: where is the growth going to come from? Viva shares have fallen by about 15 per cent since the IPO.

The burning problem for Hill and Wyatt is that cutting its wholesale fuel price for Coles will not necessarily result in higher volumes. It could simply increase pressure on its own profit margins.

The Viva prospectus promised a 7.7 per cent growth in the gross profit from its retail fuels business in the six months to December to $387 million. The Coles volume declines could affect that forecast.

The Viva propectus made a virtue of the company’s alliance with Coles when the fact is the relationship is severely strained. The alliance, which has been in place since 2003, means that 714 sites in Viva’s network are operated by Coles Express.

“This arrangement benefits Viva Energy by allowing the Company to benefit from the existing capabilities of an established nationwide retailer in areas such as inventory and people management,” the prospectus says.

“Both parties collaborate and drive growth initiatives, including through jointly planning and collaborating on network development, sharing some marketing investments and launching new products such as Shell V-Power Diesel.”

Perspective important

But the latest quarterly sales figures released by Coles on Monday show that fuel volumes sold through Coles Express declined about 16 per cent in the first quarter of this financial year, compared to a year earlier.

Viva materially lifted the wholesale petrol prices it charges Coles in February 2017. Since then fuel volumes through Coles Express have fallen about 30 per cent. This wiped about $60 million from the Coles Express earnings before interest and tax in fiscal 2018.

A possible further decline in fuel volumes in the year to June 2019 could see the Coles Express profit hit by another $50 million, according to David Errington, senior analyst at Bank of America Merrill Lynch.

It is worth putting the game of bluff in perspective. Viva is 45 per cent owned by one of the world’s largest fuel trading companies, Vitol. This privately owned company trades about 7 million barrels of crude oil every day. In 2017 it earned $US181 billion in revenue.

A company with this global reach might possibly have viewed the 3.5 billion litres of fuel traded through Coles Express as not material. But Coles Express probably accounts for 25 to 30 per cent of Viva’s earnings.

Under the terms of the alliance contract, Viva was allowed to raise its wholesale fuel prices to whatever level it liked. It took advantage of that in February 2017.

Coles had decided it would pass on the price increases directly to consumers. It did this because it wanted to protect the thin margins in its fuel business.

Coles Express, which had $130 million in earnings before interest and tax in 2018, earns a profit margin of about 2 per cent on fuel and a profit margin of 30 per cent on its convenience business.

It says a lot about the success of the Coles Express strategy that in the first quarter convenience sales rose 2.5 per cent to $1.43 billion. This includes the impact of the 16 per cent decline in comparable fuel volume growth.

Coles Express, which has been run by Alister Jordan since February last year, is sticking with a cheap and cheerful approach to convenience. It has pushed back against the industry trend of spending big on refurbishments and rolling out gourmet food.

Jordan has been shifting the focus of Coles Express to include a greater reliance on data analysis. As part of that change he has appointed a new head of fuel, Jason Tran, who previously worked at Shell. He replaces Ketan Kale, who left two weeks ago.

Extracted from AFR

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