Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn


Wesfarmers is priced for perfection

Mark LaMonica, CFA  |  10 Nov 2020Text size  Decrease  Increase  |  
Email to Friend

Wesfarmers is Australia's best-known conglomerate. Activities span discount department stores, office supplies, home improvement, energy manufacture and distribution, industrial and safety supplies, chemicals, and fertilisers. When Wesfarmers demerged consumer staple retailer Coles in 2018, hardware & home improvement retailer Bunnings became the dominant driver of the group's earnings. In fiscal 2020, Bunnings accounted for 62% of Wesfarmers' underlying earnings from operations.

Generating such a large percentage of earnings from Australia’s leading home improvement chain during a pandemic has been a blessing for shareholders. Many of us are sticking close to home and taking the opportunity to spruce up our pestilence sanctuaries, which means trip after trip to Bunnings. Wesfarmers’ share price is outperforming the overall market with a healthy return of 17.83% through close of trading on the 9th of November. The rebound from the YTD low on the 23rd of March has been nearly 58%.

Despite the strong share price performance and the positive near-term sales trends from Bunnings, Morningstar’s Director of Equity Research Johannes Faul is concerned the share price has gotten ahead of itself. Faul predicts that investors will soon redirect their focus to long-term outlook for Wesfarmers after a period of intently focus on the impact of COVID.

Faul is quick to point out that he considers Bunnings an exceptionally successful business. He expects it to continue to take market share and improve sales profitability, underpinning our wide moat rating on its parent company Wesfarmers. 

Warren Buffett has famously said he is looking to buy wonderful companies at a fair price. It is the second part of that formula for investing success where Faul has some concerns. Wesfarmer shares currently trade at a significant premium to our upgraded AUD 35.50 fair value estimate. The market is valuing Wesfarmers at 27 times consensus EPS, versus the S&P/ASX 200 at a P/E of 20, despite only low-single-digit earnings growth expected over the next three years.

Morningstar analysts have written extensively about the incredible volatility in Australian retail sales during the pandemic. We expect the distortions in consumer spending habits to return to normal.

Although the timing of a full reopening of the Australian economy is uncertain, we expect the current windfalls enjoyed in some retailing categories like hardware are temporary and there will be a return to more sustainable sales growth rates.

Investing Compass
Listen to Morningstar Australia's Investing Compass podcast
Take a deep dive into investing concepts, with practical explanations to help you invest confidently.
Investing Compass

In a detailed analysis on Bunnings, Faul upgraded his longer-term operating earnings forecast. He also increased his outlook for Bunnings' profit margins, expecting greater operating leverage and more contributions from its property developments. Faul expects Bunnings to generate sustainably higher EBITDA margins than its U.S. counterpart Home Depot.

However, current share prices imply even higher long-term sales growth targets will be achieved, and operating profit margins widen substantially—an outlook that is too optimistic for a retailer primarily exposed to the mature Australian hardware retailing market.

is a product manager, individual investor, Australia.

© 2022 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend