Wesfarmers would only lose about 1 per cent in value were it to completely close down its discount store chain Target, says Morningstar.

Morningstar retail equity analyst Johannes Faul has left his fair value estimate for Wesfarmers (ASX: WES) unchanged, saying that Target, Australia's largest department store network, was already generating little revenue.

“The advantages of the traditional brick-and-mortar retailers with large store networks are diminishing,” says Faul, who sees Wesfarmers, Australia’s largest conglomerate, as overvalued.

“However, the shuttering of about half of Target’s stores leaves our fair value estimate unscathed at $31.50. We were already forecasting Target’s contributions to be modest, at less than 2 per cent of group earnings.”

At 2pm on Wednesday, as the ASX hit highs not seen since mid-March, Wesfarmers was up 2.3 per cent at $40.54—a 30 per cent premium to Faul’s fair value estimate of $31.50.

While the announced store closures are more sweeping than Faul expected, he says the complete closure of Target would do little to erode the overall value of Wesfarmers, which generates the bulk of its earnings from big-name brands such as hardware chain Bunnings, its other discount outlet Kmart, and office supplies chain Officeworks.

“In the absence of additional expenses to exit leases early, we estimate our fair value on Wesfarmers would decline by less than 1 per cent if Target is completely folded,” Faul says.

“We expect more detail on the fate of the residual Target business at Wesfarmers’ full-year results in August 2020. Managing outstanding lease commitments would be key in minimising costs, if the group decides to close the remaining stores too.”

Faul says that while the restructure will mean costs and impairments of between $240 million to $310 million, these are a “drop in the ocean” in relation to Wesfarmers’ market cap of $44 billion.

And while the clearing of Target’s inventory could hurt department stores in the coming year, low-cost retailers like Woolworths-owned BIG W and Myer (ASX: MYR) will likely be longer-term winners, Faul says.

Dividends should be unaffected by the restructuring of Target, says Faul, estimating a fiscal 2021 dividend yield of 3.6 per cent at current share prices, and 4.5 per cent at his fair value estimate.

shoppers outside a Myer department store

While the clearing of Target’s inventory could hurt department stores in the coming year, low-cost retailers like Woolworths-owned BIG W and Myer will likely be longer-term winners

Wesfarmers’ balance sheet is also in an exceptionally strong position, Faul says, particularly following the Coles (ASX: COL) demerger last year.

As of April 2020, undrawn debt was $5 billion and cash at hand stood at $1.6 billion.

Coronavirus put a Target on stricken retailer’s back

The fallout from the coronavirus has added to Target’s woes as it was already in the crosshairs amid intensifying competition from international fashion retailers and the relentless growth of online retail, particularly that of Amazon.

Wesfarmers last week announced it would close or rebrand nearly two-thirds of its Target department stores and take one-off charges totalling up to $650 million.

With 284 stores nationwide, Target is the country’s largest department store network, but Wesfarmers fast-tracked a review of operations in April after the shutdown intended to contain the virus accelerated a sales slump.

Wesfarmers will convert up to 92 Target stores to its Kmart department store chain, and shut up to another 75 Targets, leaving as few as 117 Target outlets.

Prem Icon