Shares of Coles Group fell 7.7% to A$21.66 on Friday, their steepest one-day drop since 2020, after Australia's second-largest supermarket chain said aggressive discounting by rivals had slowed sales early in its second quarter and warned that first-half supermarket earnings would be flat.

The close was Coles's lowest since late March 2020, Reuters reported, and the stock had been down as much as 12.8% during the session. For investors in Asia who hold Australian consumer names as defensive income plays, the update was a reminder that grocery margins are under pressure from two directions at once: price-hunting shoppers and rising fuel bills.

Coles sales slow as Woolworths discounts harder

In its first-quarter sales release to the ASX, Coles said supermarket revenue rose 3.6% to A$10.32 billion in the 13 weeks to Sept. 27, from A$9.97 billion a year earlier. Comparable sales growth slowed to 2.7%, down from 4.6% in the same quarter last year.

Group sales revenue rose 2.2% to A$11.21 billion. That fell short of the A$11.31 billion that analysts expected, according to Visible Alpha data cited by Reuters. Liquor sales fell 1.3% to A$831 million, and revenue in the Other segment dropped to A$58 million as a fuel supply agreement with Viva Energy winds down ahead of its expiry in November.

There were bright spots. Online supermarket sales jumped 22.9% to A$1.62 billion, lifting eCommerce to 15.7% of supermarket sales. Coles Finest, the premium own-brand tier, grew sales 13.3%. Supermarket price inflation held at 1.1%.

The weakness came in the outlook. Coles said cost-of-living pressure and "elevated competitor promotional activity" kept weighing on shoppers in the first four weeks of the second quarter, and that supermarket sales growth had moderated from the first-quarter pace. It also expects higher fuel-related costs in the first half than a year earlier. As a result, the company now sees first-half supermarket earnings before interest and tax, excluding significant items, in line with the prior corresponding period.

Managing Director and CEO Leah Weckert said in the release that households were shopping more deliberately across retailers and channels, and that Coles would sharpen its offer in the coming months. The company has relaunched its Every Day Price program, which Reuters said locks lower prices on selected products for at least six months, and has launched its largest-ever Exclusive to Coles Christmas range.

The comparison with Woolworths stung. Its larger rival reported 6.9% growth in its Australian Food segment for its first quarter, Reuters said, and Woolworths shares closed 1.9% higher on Friday. David Tuckwell, chief investment officer at ETF Shares, told Reuters that "Christmas trading will be the real test" for Coles.

ASX 200 ends October higher despite retail drag

The selloff in Coles came on a day when the broader market inched up. The S&P/ASX 200 rose 16 points, or 0.2%, to 8,908 on Friday, according to Trading Economics, after a morning rally to a seven-week high faded when U.S. stock futures fell on a drop in Alphabet shares. The benchmark gained 1.3% for the week and 1.4% for October, Trading Economics said, recovering part of September's 3.2% loss.

Retailers were already under strain. On Thursday, the S&P/ASX 200 rose 0.5% to 8,891.5 as bank stocks rebounded, but cyclical retail shares fell 2% after soft trading updates from Wesfarmers, JB Hi-Fi and Super Retail, according to an Australian Associated Press report published by Commonwealth Bank of Australia. Financial stocks reached their highest level since Aug. 10, the report said.

Wesfarmers recovered on Friday, rising 3.2%, while Woolworths gained 1.9%, Trading Economics said. That left Coles as one of the worst performers in the index, according to Reuters.

What investors watch next for Coles and Australian shares

The pressure on Coles comes as Australian households face tighter monetary policy. Core inflation came in above forecasts in the September quarter, and traders were weighing a further rate increase by the Reserve Bank of Australia at its next meeting, after four increases this year, according to Trading Economics, with Governor Bullock warning that inflation could stay higher for longer.

For Coles, the next hard numbers arrive with first-half results, which will show whether the Every Day Price push wins back shoppers without eroding margins that management has already guided flat. The company's own release named the Christmas trading period as the key stretch for its value investments.

Before that, the RBA decision this week will set the tone for rate-sensitive consumer stocks across the ASX 200.