Wesfarmers’ (ASX.WES) underlying net profit after tax increased by 8% to $2.9 billion in fiscal 2026. The conglomerate’s two largest segments, Bunnings and Kmart, underpinned the result, as did higher lithium prices. Heading into fiscal 2027, Kmart and lithium earnings are under pressure. Shares fell 5%.

Why it matters: Underlying earnings of $2.53 per share were broadly in line with our $2.55 estimate. However, sales momentum in retail chains Bunnings, Kmart, and Officeworks was softer than we expected, and we trim our fiscal 2027 EPS estimate by 5% to $2.60. A 3% increase year on year.

  • At Kmart and Officeworks, we expect low-single-digit sales growth combined with cost inflation, especially for labor, to weigh on near-term profit growth. Here, we forecast slight margin declines. But at Bunnings, we believe stronger sales momentum will drive marginal margin expansion year on year.
  • Lithium was an important swing factor, and we don’t expect a repeat. Group underlying pretax profit growth of 6% included a $100 million swing in lithium earnings. Without it, pretax profits were up 4%. We expect lithium profits to increase by only $20 million in fiscal 2027.

The bottom line: We lower our group EBIT estimates on average by 3% on lower retail sales and lower lithium earnings due to higher costs. However, these are not sufficient to alter our $58 fair value estimate for wide-moat Wesfarmers. Shares are materially overvalued.

  • At our fiscal 2027 earnings estimate, shares trade at about 30 times. We think this is too expensive for a stock offering an estimated fiscal 2027 yield of just 3% and only single-digit earnings growth over the medium term.
  • We forecast Bunnings, accounting for 60% of midcycle profits, to outperform the hardware retail sector. We anticipate category expansion, like home appliances, to support sales growth of 5% per year over the medium term, similar to the average growth rate in the five years to fiscal 2026.

Wesfarmers’ profit growth supported by large swing in lithium performance

Wesfarmers is Australia’s best-known conglomerate. Activities span discount department stores, office supplies, home improvement, energy manufacturing and distribution, industrial and safety supplies, chemicals, and fertilizers. Business interests can be divided into two broad groups: retail and industrial.

The company’s hardware store footprint across the Australian economy and its leading market positions within several segments, combined with strong underlying return on invested capital (before goodwill), lead to our wide moat rating.

Wesfarmers is one of Australia’s largest retailers, and despite the Coles demerger, it still earns around 80% of sales from the retail channel across discount department stores, hardware/home improvement, and office supplies.

Wesfarmers has generally funded organic growth and relatively small acquisitions without issuing new capital through its sound management of operating cash flow and selective divestments from its operational portfolio. Through Bunnings, Wesfarmers has the largest market share (approaching 25%) in a highly growing but fragmented home improvement sector. Wesfarmers’ Kmart and Target stores have the largest market share in the discount department store sector. Chemicals operations provide a significant but more volatile contribution to group cash flow and earnings.

Key risks involve increased competition in the retail sector, structurally weak growth in real consumer spending compounded by a cyclical downturn, and lower commodity prices. Discount department-store operations Target and Kmart are exposed to increased frugality and heightened deflationary pressures affecting top-line sales growth, while the remaining operations would be affected by persistent GDP growth below Australia’s long-term trend.

Wesfarmers is well placed to weather the challenges with its solid balance sheet, imposing cash generation, and good management. Following the demerger of Coles in fiscal 2018, we anticipate the group will engage in more meaningful corporate activity given Wesfarmers’ relatively smaller size and strengthened balance sheet.

Bulls Say

  • Bunnings is the undisputed leader in Australian home improvement retailing. Based on its market position, Bunnings could start giving up some volume growth and improve profitability by increasing prices.
  • The diversification of Wesfarmers’ revenue streams across multiple retail categories and industrial businesses lowers earnings volatility and better predictability of dividends for income investors.
  • Wesfarmers’ strong balance sheet lowers funding costs, but also provides the financial firepower to opportunistically pursue acquisitions.

Bears Say

  • Wesfarmers’ retailing businesses are procyclical. Consumer discretionary spending could be significantly softer during a severe economic downturn.
  • While recent acquisitions have been measured, they introduce risk and can be value-destructive to shareholders. For instance, the relatively small Homebase and Catch Group acquisitions failed to deliver value.
  • The department store segment is grappling with intense competition from online retailers like Amazon and Temu, but is also confronted with the secular decline of the department store format.

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