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Wesfarmers remains expensive despite online push

Lex Hall  |  09 Jun 2021Text size  Decrease  Increase  |  
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Wesfarmers (ASX: WES) has embraced the digital revolution, but it has come at a cost and the wide moat conglomerate that oversees Bunnings, Kmart and Officeworks remains expensive, says Morningstar.

Wesfarmers, which is up 30 per cent in the past year, used its recent strategy day to herald improvements in its ability to sell goods online, particularly at its flagship hardware store Bunnings and its discount retailer Kmart.

Before current chief executive Rob Scott arrived in 2017, both Bunnings and Kmart had scant online penetration. But there is marked improvement, says Morningstar analyst Johannes Faul.

In the six months to December 2020, online sales penetration peaked at 3 per cent at Bunnings and 11 per cent at Kmart Group, excluding online pure-play Catch, which Wesfarmers acquired in 2019. This compares to 9 per cent for the Australian retailing industry.

But as Faul notes, it has been and will continue to be an expensive exercise for Wesfarmers as it shifts focus from stores to online. Morningstar estimates that by 2030, over a fifth of all Australian retailing transactions will be done online.

Wesfarmers, the second-largest non-food online retailing group in Australia behind Amazon, invested $200 million in digital and data in fiscal 2020, and Faul estimates a similar amount was spent again in fiscal 2021.

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“Management intends to gear up these investments in digital with some $100 million to be spent over fiscal years 2022 and 2023,” Faul says.

“We anticipate Wesfarmers’ retailer businesses to further reallocate funding to the online channel, away from store rollouts and refurbishments, as the online channel gradually increases in importance.”

Faul continues to see Wesfarmers as significantly overvalued. At the close on Wednesday, the company was down 0.71 per cent at $54.33, as the broader market hit an intra-day high. Wesfarmers is overvalued by 46 per cent according to Faul’s fair value estimate of $37.50.

On the dividend front, Faul says the outlook for household income and business activity is much improved and management is assessing tax effective ways to return capital to shareholders.

Morningstar estimates the full-year fiscal 2021 dividend at $1.89 and at $1.84 in fiscal 2022, representing dividend yields of 3.4 and 3.3 per cent, respectively, at current prices.

Wesfarmers (WES) v Morningstar Australia GR Index - 1YR

A chart showing the Wesfarmers share price v the Morningstar Australia GR AUD index 1YR

Source: Morningstar Premium

Retail sales slow

Despite the Coles demerger in 2018, Wesfarmers still earns about 80 per cent of sales from the retail channel across Kmart, Bunnings, and Officeworks.

But the run-up in Wesfarmers’ share price over the past year, retailing sales growth is slowing from unsustainably high spending levels, Faul says.

“The stock market is possibly overestimating the growth potential of Wesfarmers’ existing portfolio of businesses, mostly operating in mature markets.”

Hardware retailing sales have fallen by 5 per cent in April 2021, compared with April 2020, according to ABS data.

“Bunnings generates close to two-thirds of Wesfarmers' earnings and is the most important driver of the top line in our model. We forecast midcycle revenue growth of 6 per cent per year, ahead of the Australian hardware retailing market at 5 per cent. We forecast Bunnings' earnings before taxes margins to remain relatively flat at around 14 per cent compared with 12.2 per cent in fiscal 2020.”

Kmart Group is Wesfarmers’ second-largest business, accounting for about 15 per cent of group midcycle EBT. Faul forecasts the department store sector to continue losing customers to specialty brick-and-mortar stores and online pure-play retailers.

“We expect Kmart to outperform Target, because of its clear market positioning as the price leader. We expect virtually flat sales for the combined Kmart Group over the next decade.”

Medium uncertainty

Wesfarmers has a strong balance sheet and strong management, which Faul expects will insulate it from increased competition and weak growth in consumer spending.

However, there are risks, which are reflected in its medium uncertainty rating. Retailing businesses hinge on the health of the economy, the near-term outlook of which is mixed at best, Faul says.

Secondly, mergers and acquisitions are risky and can diminish value for shareholders. Faul cites as examples Wesfarmers' most recent acquisition, Homebase in the UK and Kidman Resources, describing them as ill-timed and costing investors dearly.

Finally, the department store is in decline generally, Faul says, and at the same time faces intense competition from online, international apparel retailers and most importantly Amazon Australia.

is senior editor for Morningstar Australia

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