Wesfarmers Ltd (WES) – BUY
FY18 was a turning point for Wesfarmers (WES), after significant changes and repositioning of its portfolio, with the group’s proposed demerger of Coles (Nov 2018) and divestments of Curragh mining and Bunnings UK and Ireland (BUKI).
|Date of Report||ASX||Price||Price Target||Analyst Recommendation|
|Date of Report|
|Sector : Consumer Staples||52-Week Range: A$40.29 – 52.70|
|Industry: Food & Staples Retailing||Market Cap: A$59,447.2m|
We rate WES as a Buy for the following reasons:
- Diversified asset base with core assets continuing to grow (Bunnings)
- Expect improved performance from Target and Industrials businesses.
- Disposal of struggling business BUKI and Curragh Mine, and FY19 disposal of KTAS, and partial disposal of Bengalla, reducing earnings volatility and strengthening balance sheet.
- On-going focus on shareholder return including attractive yield.
- Strong management team, new CEO likely to bring the same WES discipline (given he is an internal appointment) but his own style to the leadership of the company.
- Strong balance provides flexibility to take advantage of opportunities as they arise.
- Potential capital management initiatives.
We see the following key risks to our investment thesis:
- Margin erosion due to competitive pressures.
- Deterioration in balance sheet metrics.
- Execution risk with Homebase in the UK.
- Continual slide in performance of Bunnings UK and Ireland.
- Deterioration in coal prices.
- Adverse movements in AUD/USD.
Figure 1: WES Revenue by Segment
FY18 was a turning point for Wesfarmers (WES), after significant changes and repositioning of its portfolio, with the group’s proposed demerger of Coles (Nov 2018) and divestments of Curragh Mining and Bunnings UK and Ireland (BUKI).
On a continuing operations basis, group underlying EBIT was up +4.5% and NPAT was up +5.2% on previous corresponding period (pcp). Whilst Bunnings ANZ (BANZ) reported another solid result (EBIT up +12.7%), it was the growth in Department stores’ EBIT (up +21.5%) that exceeded all expectations. The strong earnings growth appears to be driven by gross margin and cost of doing business improvements, although the former probably played a larger part, in our view.
Food and liquor revenues increased +1.6% over pcp with headline sales up +2.1% and comparables sales up +1.8%. These numbers suggest Coles had a much stronger second half. We expect sales growth to stabilize here and margins to improve. The group’s balance sheet remained strong, with strong cash generation and net debt declining -17.1% to $3.58bn. With WES’ business portfolio now largely streamlined, the question is where to from here?
With a strong balance sheet, investors are looking to management to see where they invest next. Given the experience of BUKI, we do expect management to be more cautious with their investment criteria. In the absence of a material investment opportunity, we expect shareholder returns to be on top of the priority list. Maintain Buy.
- Coles appears to be making up ground on Woolworths. Total revenue of ~$39bn was broadly flat on FY17 (flat); EBIT declined -6.8% to $1.5bn, with EBIT margin of 3.8% dropping 30bps from pcp (4.1%). It was noted that the subdued earnings were due to the annualization investments made in the customer offer in the prior year, one-off profit on the sole of properties, and lower Convenience earnings. Food and liquor revenues increased +1.6% over the pcp with headline sales up +2.1% and comparables sales up +1.8%. These numbers suggest Coles had a much stronger second half. Deflation continued, at 1.8%, reflecting continual price pressures in a competitive market and seasonal factors, particularly in fresh produce (which accelerated in the fourth quarter).
- Bunnings ANZ (BANZ) solid but moderating. BANZ had another solid year, with operating revenue up +8.9% to $12.5bn, and EBIT up +12.7% over the pcp. Although fourth quarter sales appear to have moderated and some may extrapolate this as a trend for the rest of FY19. Following the divestment of BUKI, earnings growth was furthered by a greater number of one-off costs relating to store closure provisioning, asset writedowns in the pcp. This divestment has also led to further investment into new stores and store refurbishment.
- Department stores the standout. Total revenue for the segment was up +3.6% over the pcp, with earnings jumping +21.5% over the pcp. Detail was a little light on this front however, the market is likely going to question the sustainability of this growth including EBIT margin expansion of +110bps.
ASK THE ANALYST
Our analysts are ready to answer any questions you have
WES FY18 RESULTS SUMMARY…
Figure 2: WES FY18 results summary
Coles earnings continue to slide, however stabilization in sight.Total revenue of ~$39bn was broadly flat with FY17 (flat); EBIT declined -6.8% to $1.5bn, with EBIT margin of 3.8%, dropping 30bps from pcp (4.1%). It was noted that the subdued earnings were due to the annualization investments made in the customer offer in the prior year, one-off profit on the sole of properties, and lower Convenience earnings. Food and liquor revenues increased +1.6% over the pcp with headline sales up +2.1%, while comparables sales up +1.8%. Deflation continued, at 1.8%, reflecting continual price pressures in a competitive market and seasonal factors, particularly in fresh produce (which accelerated in the fourth quarter).
Bunnings ANZ (BANZ). In May 2018, Wesfarmers entered an agreement to divest the assets of the previously struggling Bunnings UK & Ireland (BUKI) business for a nominal amount. BANZ on the other hand continued to perform strongly, with operating revenue up +8.9% to $12.5bn, and EBIT up +12.7% over the pcp. This strong performance can be attributed to solid execution of customer value investments, introduction of online transactional capacities, as well as further operating cost controls and favourable property divestments. Following the divestment of BUKI, earnings growth was furthered by a greater number of one-off costs relating to store closure provisioning, asset writedowns in the pcp. This divestment has also led to further investment into new stores and store refurbishment (predominately funded by WES’ property recycling program) – 10 net new trading locations and 13 stores under construction during the period.
Department store strength. Total revenue for the segment was up +3.6% over the pcp, with continuing growth strength in Kmart partially offset by ongoing troubles at Target. Earning jumped +21.5% over the pcp. Wesfarmers also announced the sale of Kmart Tyre & Auto (KTAS), with the sale to be completed in 1Q18 and to be recognized in FY19 and expects to record pre-tax profit on sale of between $270-275m. Management maintains that the Department Stores division is well positioned for the future.
Strong cash flows and strengthening balance sheet.Wesfarmers again reported strong operating cash flows for the half, although with a decline of 3.5% to ~$4.1bn, reflecting higher tax payments for earning from Resources and that which was paid in FY18. The neutral working capital result was indicative of increased net working capital investment in BANZ to support store network growth, as well as the AU/NZ Kmart brand acquisition and BUKI inventory clearance prior to its disposal. Net Capex of $1.2bn (up +17.6m on pcp) due to increase in BANZ store openings partially offset by lower capital spend on Coles. Balance sheet strengthened over the half, with net debt at $3.6bn (down from $741m over the pcp), reducing finance costs by -16.3% to $221m. Proceed from the sale of the Curragh mine was partially offset by cash retained from BUKI to support working capital requirements and financial obligations, leading to investing cash flows $424m lower than last year (includes proceeds on disposal of Coles credit card receivables of $947m).
Sale of Bengalla.On Aug 2018, Wesfarmers announced an agreement to sell 40% of its interest in Bengalla for $860m. The Group expects to record a pre-tax profit on sale of between $670-680m, further strengthening the balance sheet and reducing earnings volatility from the group’s profile.
Figure 3: WES Financial Summary
Source: BTIG, Company, Bloomberg
Wesfarmers Limited (WES) has diverse business operations covering supermarkets, liquor, hotels, convenience stores, home improvement, office supplies, and department stores. The company also has an industrials division which includes businesses in chemicals, energy and fertilizers, industrial and safety products and coal. Wesfarmers employs over 220,000 people.
Recommendation Rating Guide
|Recommendation Rating Guide||Total Return Expectations on a 12-mth view|
|Speculative Buy||Greater than +30%|
|Buy||Greater than +10%|
|Neutral||Greater than 0%|
|Sell||Less than -10%|
Reach Markets Disclaimer
Reach Markets Pty Ltd (ABN 36 145 312 232) is a Corporate Authorised Representative of Reach Financial Group Pty Ltd (ABN 17 090 611 680) who holds Australian Financial Services Licence (AFSL) 333297. Please refer to our Financial Services Guide or you can request for a copy to be sent to you, by emailing [email protected].
Read our full disclaimer here >
This publication contains general securities advice. In preparing the advice, Reach Markets Australia has not taken into account the investment objectives, financial situation and particular needs of any particular person. Before making an investment decision on the basis of this advice, you need to consider, with or without the assistance of a securities adviser, whether the advice in this publication is appropriate in light of your particular investment needs, objectives and financial situation. Reach Markets Australia and its associates within the meaning of the Corporations Act may hold securities in the companies referred to in this publication. Reach Markets Australia does, and seeks to do, business with companies that are the subject of its research reports. Reach Markets Australia believes that the advice and information herein is accurate and reliable, but no warranties of accuracy, reliability or completeness are given (except insofar as liability under any statute cannot be excluded). No responsibility for any errors or omissions or any negligence is accepted by Reach Markets Australia or any of its directors, employees or agents. This publication must not be distributed to retail investors outside of Australia.
It is recommended that you seek independent advice and read the relevant Product Disclosure Statement before making a decision in relation to any investment. Any advice contained in this communication is general and has not taken into account the investment objectives, financial situation and particular needs of any particular person.
Banyan Tree Disclaimer
This document is provided by Banyan Tree Investment Group (ACN 611 390 615; AFSL 486279) (“Banyan Tree”).
The material in this document may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts. This document does not purport to contain all the information that a prospective investor may require. The material contained in this document does not take into consideration an investor’s objectives, financial situation or needs. Before acting on the advice, investors should consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. The material contained in this document is for sales purposes. The material contained in this document is for information purposes only and is not an offer, solicitation or recommendation with respect to the subscription for, purchase or sale of securities or financial products and neither or anything in it shall form the basis of any contract or commitment. This document should not be regarded by recipients as a substitute for the exercise of their own judgment and recipients should seek independent advice.
The material in this document has been obtained from sources believed to be true but neither Banyan Tree nor its associates make any recommendation or warranty concerning the accuracy, or reliability or completeness of the information or the performance of the companies referred to in this document. Past performance is not indicative of future performance. Any opinions and or recommendations expressed in this material are subject to change without notice and Banyan Tree is not under any obligation to update or keep current the information contained herein. References made to third parties are based on information believed to be reliable but are not guaranteed as being accurate.
Banyan Tree and its respective officers may have an interest in the securities or derivatives of any entities referred to in this material. Banyan Tree does, and seeks to do, business with companies that are the subject of its research reports. The analyst(s) hereby certify that all the views expressed in this report accurately reflect their personal views about the subject investment theme and/or company securities.
Although every attempt has been made to verify the accuracy of the information contained in the document, liability for any errors or omissions (except any statutory liability which cannot be excluded) is specifically excluded by Banyan Tree, its associates, officers, directors, employees and agents. Except for any liability which cannot be excluded, Banyan Tree, its directors, employees and agents accept no liability or responsibility for any loss or damage of any kind, direct or indirect, arising out of the use of all or any part of this material. Recipients of this document agree in advance that Banyan Tree is not liable to recipients in any matters whatsoever otherwise recipients should disregard, destroy or delete this document. All information is correct at the time of publication. Banyan Tree does not guarantee reliability and accuracy of the material contained in this document and is not liable for any unintentional errors in the document.
The securities of any company(ies) mentioned in this document may not be eligible for sale in all jurisdictions or to all categories of investors. This document is provided to the recipient only and is not to be distributed to third parties without the prior consent of Banyan Tree.
This document has been commissioned by Reach Markets Australia Pty Ltd and provided by Banyan Tree Investment Group (ACN 611 390 615; AFSL 486279) (“Banyan Tree”).