Coles switch in doubt

They are worried that FoodWorks, a chain of 710 mainly owner-operated shops, would not provide the same income security as the Coles brand, which is owned by ASX top-20 company Wesfarmers.

The ACCC recently approved the transfer of 45 Coles supermarket leases, including eight in Victoria and 19 in NSW, to FoodWorks for $35 million. Landlords and FoodWorks shareholders must still agree to the deal.

One Victorian landlord, who declined to be named, confirmed that he would attempt to contest the transfer.

"We are in discussions with Coles in relation to it and obviously we will be trying to stop it happening, but we can't guarantee it," he said.

Another NSW supermarket owner said he would be surprised if his bank did not insist on adjusting the conditions of his loan because of the perceived risk of the new tenant.

"The banks won't muck around on this. They'll say my property isn't a Coles property anymore . . . we don't like it as much. If the sales volume goes down, the rent goes down, and we're going to have to cough up extra security so our loans are within the confines."

FoodWorks shareholders will vote on the deal on August 17. Rivals are rumoured to be trying to jeopardise the vote by raising concerns about FoodWorks chief financial officer Michael Reddrop. Mr Reddrop is former CFO of Chinese supermarket chain Global Mart, which went into receivership in April, months after Mr Reddrop's resignation.

FoodWorks chief executive Peter Noble was travelling interstate and did not return calls. He wrote in an email that he was confident his management team would make the new stores successful, and that they were "well-suited to deliver profitability under the FoodWorks business model". He said FoodWorks had "fresh, vibrant store fit-outs" with personal service and product ranges tailored to different markets.

Unlike Woolworths and Coles, FoodWorks does not have a FlyBuys, frequent flyer or petrol discount scheme. Instead it has a "reverse" fuel deal, in which shoppers who present petrol receipts can get a discount on their groceries.

Coles will loan FoodWorks the cash for the $35 million lease exchange, as well as $12 million for renovations and other transfer costs. Eight stores from struggling discount chain BiLo are part of the transfer.

Coles spokesman Jim Cooper said the stores selected for transfer were "good stores but not suitable for our business model". Some stores were too small, and "in many cases" had other Coles or BiLo stores nearby.

He said the company would be negotiating with the landlords on a case-by-case basis.

Past examples of supermarket lease transfers include discount chain Franklins assigning its lessee interests to Coles, Safeway and independent retailers in 2001.

Supermarket valuer Shane Close of Charter Keck Cramer said while "that was an instance where the lease covenant was generally viewed as being stronger", the Coles transfer could be more problematic.

"If the pro forma quality of the tenant is less than what they have at the moment, that is quite often grounds to not permit the lease assignment," he said.

"The strength of the lease covenant may not be as strong, but the landlords still have the right to approve or reject that lease."

He said negotiations could see Wesfarmers offering a guarantee of rental income or a bank guarantee. But properties still risked selling poorly at auction, reflected by a higher yield, which is the rent a property generates relative to the price.

"Supermarkets such as Safeway and Coles in general terms might be selling on yields of 7 to 8 per cent. If there is an assignment and the supermarket operator is an independent of less profile . . . that may impact on the yield."

A Coles store was auctioned in Wonthaggi in June, five days before Coles announced its lease would be transferred to FoodWorks. It passed in on a vendor bid that sources say reflected a lower price than the owner paid five years ago.