In a very disruptive retailing environment, Wesfarmers WES is proving defensive. Its earnings have been less volatile than earnings of other large-cap cyclicals over recent years marked by lockdowns and massive stimulus, followed by rampant inflation, rising mortgage rates, and cost-of-living pressures.

Why it matters: We now expect low earnings volatility of Wesfarmers’ existing portfolio to persist, and revise our cost of equity to 7.5% from 9.0%. It now matches that of defensive retailers Woolworths and Coles, which exhibited similar low earnings volatility over the six years to fiscal 2025.

  • Our estimated weighted average cost of capital for Wesfarmers declines to 7.2% from 8.6%. However, our earnings estimates are virtually unchanged. We expect annual earnings growth to average 8% over the next five years, supported by lithium hydroxide sales commencing and lithium prices rebounding.
  • This contrasts with the lackluster growth over the five years to fiscal 2024, with a compounded annual growth rate (“CAGR”) of merely 2% over the period, although against a highly disruptive macro backdrop. For fiscal 2025, we forecast EPS to increase by 3% to $2.33.

The bottom line: Reducing our discount rate materially boosts our valuation. We increase our fair value estimate for wide-moat Wesfarmers by 30% to $58. Reflecting our improved appreciation of its earnings resilience, we lower our Morningstar Uncertainty Rating to Low, from Medium previously.

  • Despite our large fair value upgrade, shares are significantly overvalued. Our fair value already incorporates strengthening sales momentum and margin expansion at Bunnings, as well as lithium prices more than doubling in the midterm, partially offset by softer profit margins at Kmart.
  • We believe the market is much more optimistic on Wesfarmers’ outlook. For instance, assuming Kmart achieves its aspirational target of doubling sales over the long term, while also holding profit margins at current peak levels, would increase our valuation by $7 per share.

Kmart’s Aspirational Target Contingent on Anko’s Success Overseas

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 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, 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 compounding 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’ relative smaller size and strengthened balance sheet.

Wesfarmers bulls say

  • The 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.

Wesfarmers 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 are also confronted with the secular decline of the department store format.

Get Morningstar insights in your inbox

Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Uncertainty Rating: The Morningstar Uncertainty Rating assesses business risk and our analysts’ ability to gauge Fair Value. Mark LaMonica discussed business risk in more depth in this article.