Wesfarmers Ltd
ASX code: WES
Share price: $42.72
Industry: Retailers
Forecast FY2016
Dividend: $2.03 fully franked
One of the lessons for investors this year is that retailers that execute really well can build up powerful momentum. So it is with retail conglomerate Wesfarmers, where the core retail businesses recently reported another set of high-quality sales results for the March quarter.
In response we left our $42 valuation unchanged (it is trading at about $42.72 now) but lifted our buy price from $39 to $40. The fully franked dividend yield at $40 is 5.1 per cent, which is full for a stock we rate as low-risk.
Wesfarmers continues to outperform in supermarkets, despite price deflation there, and across its other main retail business. This is partly driven by rival Woolworths’ underperformance in the supermarket, home improvement and discount department store categories — Wesfarmers owns Coles. Over the year to the March quarter food & liquor grew sales 5.9 per cent, and Bunnings, Officeworks and Kmart sales were 11 per cent, 5.6 per cent and 17.9 per cent higher, respectively. Together these businesses account for over 90 per cent of total earnings, so the group is travelling well.
Food & liquor price deflation increased to 2.0 per cent in the March quarter, up from 1.0 per cent in recent quarters, with nearly all categories contributing. Although this slowed the growth of Coles food & liquor same-store sales to 4.9 per cent from 5.3 per cent in the December quarter, it was still a strong result and signals downside to Woolworths’ March quarter supermarket sales to be
released to the market today. Watch out.
Bunnings delivered its 12th consecutive quarter of 10 per cent-plus sales growth. So far discounting by rival Masters seems not to have slowed Bunnings down much at all. There might be a modest, temporary drag from discounting by Masters associated with its upcoming sale or closure. Also for Wesfarmers the early results from the recently acquired Homebase home improvement and garden retailer in Britain will be poor, given recent bad weather there and earlier inferior management.
The Kmart result was extraordinary and includes some cannibalisation of Target as well as market share gains from rival Big W, which is still underperforming. Ahead of Big W’s anticipated turnaround, the divisional merger of Kmart and Target is a good idea. Australia has too many discount department stores and Wesfarmers’ internal rationalisation is a sharp move ahead of Big W’s
rejuvenation.
Value investors know the trickiest task is not to pay too much for a business and to choose a portfolio weighting that reflects the amount of upside and how likely it is to be realised. With Wesfarmers the risks boil down to whether now is “peak Wesfarmers” given Woolworths has appointed new management and will gradually turn itself around. The March quarter sales results for Coles were
impressive but margins will be a different story when the second-half results are reported in August, as Woolworths’ discounting is forcing Coles to match. In time Woolworths will also recover some market share. Aldi will take more share in WA and longer-term there is the threat from Amazon, which has not yet unveiled expansion plans in Australia.
All things considered, we require only a small discount to value when buying Wesfarmers, and our $40 buy price is at only a 5 per cent discount to our $42 valuation. The operations are performing strongly and likely to continue doing so all year. This is an outperforming stock worth owning and the dividend is likely to edge higher, so the effective dividend yield should rise over time from the starting yield.
Written by David Walker: Senior Analyst at Clime Investment Management.
OWNERSHIP DISCLOSURES:
Clime Asset Management owns shares in WES on behalf of various mandates for which it acts as investment manager.