21 November 2019
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Wesfarmers, brought to you by Bunnings

Paul Rickard
29 August 2019

Australia’s largest conglomerate, Wesfarmers, should probably consider changing its name to Bunnings. Following the divestiture of Coles, Bunnings accounts for 55% of Wesfarmers group EBIT and is driving earnings growth. As a standalone investment, it returns a staggering 50.5% on the capital Wesfarmers has invested.

On the back of total sales growth of 5.2% and store-on-store sales growth of 3.9%, Bunnings EBIT for the 2019 financial year rose by 8.1% from $1,504m to $1,626m. This helped Wesfarmers post EBIT from continuing operations of $2,974m, up 12.2% on 2018’s $2,650m. After tax, and including $3,171m of extraordinary gains realised on the sale of Coles and other assets, Wesfarmers reported a net profit of $5,510m for the full year.

Officeworks also starred, with sales up 7.6% and EBIT 7.1% to $167m. The Chemicals, Energy and Fertiliser division delivered an improved performance, due to higher sales and more favourable external conditions. EBIT rose by 14.2% to $438m.

Offsetting these performances were Industrials and Safety (EBIT down 27.1% to $86m due to challenges with Blackwoods) and the discount department store businesses, which have been consolidated into the Kmart group. Earnings decreased by 13.7% from $626m in FY18 to $540m in FY19.

Wesfarmers has stopped itemising the losses of the troubled Target business, the other part of the Kmart group. It did note that sales in Target stores continued to fall, down 1.5% for the year. Meanwhile, sales in Kmart branded stores rose by 1.5% but were flat on a comparable store basis.

Since taking over two years’ ago, Wesfarmers Managing Director Rob Scott has been repositioning the conglomerate. He has divested Homebase, the chain of UK home improvement stores that Wesfarmers tried to “Bunningsise” and failed. He has demerged the Coles supermarket, convenience store and liquor business, creating a separately listed ASX entity that Wesfarmers maintains a minority 15% stake in.

Other sales have included:

·      Wesfarmers 40% interest in the Bengalla JV thermal coal mine in the Hunter Valley for $860m. This completed Wesfarmers exit from coal mining (the sale of the Curragh mine was finalised in March 2018);

·      The Kmart Tyre and Autoservice business for $350m; and

·      A 13.2% indirect interest in Quadrant Energy for US$170m.

But as if wanting to lend support to the adage that it is “harder to acquire a business than sell a business”, Scott has struggled to find replacement assets. He dabbled with plans to buy troubled rare earths producer Lynas before launching a $776m bid for lithium miner Kidman Resources and spending $230m on buying online retailer Catch Group.

Catch is allegedly profitable and cash generative (Wesfarmers hasn’t provided details), while the market is starting to say that Scott has overpaid with his bid for Kidman. The deal is expected to be endorsed by Kidman’s shareholders when they meet next Thursday.

Organic growth has also alluded Scott, with gross capital expenditure decreasing by $80m in FY19 to $860m as Bunnings get close to saturation coverage in the Australian market, weak consumer spending hurts the discount department stores, and the industrials division battles a less favourable trading environment.

Scott’s investing in data and digital, including (according to Wesfarmers) a “step-change digital offer”. But translating this to material revenue growth could prove to be challenging.

So far, his report card reads something like: “easy to sell, hard to buy, and even harder to grow organically”.

What do the brokers say?

The brokers see Wesfarmers shares as being overvalued. “Rich” is the word Morgan Stanley uses to describe the current market valuation. According to FN Arena, the broker consensus target price is $35.08, some 10.7% lower than yesterday’s closing price of $39.28. Morgan Stanley is the most bearish at $32.00, while Macquarie is the most bullish at $37.50. There are 4 neutral recommendations and 3 sell recommendations, and no buy recommendation.

Following the profit result on Tuesday, several brokers revised upwards their target price, with the consensus rising from $33.11 to $35.08. This didn’t translate to an increase in forecast earnings, which brokers now expect to fall marginally to 166.1c per share for FY20 compared to an adjusted 171.5c in FY19. Ord Minnett (JP Morgan) described the earnings trajectory as “weak”. Others noted the lack of organic growth.

At the current price, Wesfarmers is trading on a multiple of 23.7 times forecast FY20 earnings and 22.7 times forecast FY21 earnings. The dividend is expected to drop to around $1.52 per share (the $2.78 paid in FY19 included a special dividend of $1.00 and five months of earnings from Coles), putting Wesfarmers on a prospective yield of 3.9% (fully franked).

The bottom line 

In the current climate, Wesfarmers is viewed as a relatively low risk stock with reasonably predictable earnings. While not typically labelled a “defensive”, it is starting to demonstrate some of these characteristics. This goes some way to explaining why it is trading on such a high multiple.

Take away Bunnings however, the conglomerate’s other business are considered by many to be in the “take it or leave it” category. Purchases of Kidman Resources and Catch are unlikely to change this assessment.

With Wesfarmers struggling to grow revenue and earnings, and the jury still out on Scott, the stock is expensive. Definitely not a buy, more a long term sell near $40, but at the same time, unlikely to fall away too far in the short term.

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