FY17 result was broadly in line with our expectations
Underlying EBIT increased 22% to A$4,402m while underlying NPAT also grew 22% to A$2,873m. Group underlying EBIT margin rose 90bp to 6.4%. The result was driven in particular by stronger earnings from the Resources division on the back of higher coal prices. In the retail businesses, higher earnings at Bunnings (in Australia and New Zealand), Kmart, Officeworks and an improved performance from Target offset weakness in Coles and Bunnings in the UK and Ireland.
The balance sheet remains strong with solid credit metrics – fixed charges ratio at 3.1x (FY16; 2.7x) and cash interest cover at 25.0x (FY16: 16.8x). Return on equity increased 280bp to 12.4% while operating cash flow was up 26% to A$4,226m. FY17 DPS of 223cps was up 20% on the prior year reflecting a strong cash flow and balance sheet position.
Coles was the key disappointment – Target was positive
While Coles' FY17 revenue was flat at A$39.2bn, EBIT dropped 14% to A$1,609m. The result was 6% below our forecasts reflecting a larger than expected fall in EBIT margin as Coles continues to invest in price at the expense of earnings in a highly competitive environment. Despite the difficult backdrop, Food & Liquor like-for-like sales growth of 1.0% was slightly ahead of our 0.8% forecast.
Target delivered EBIT of -A$10m which was a significant improvement on last year (-A$195m). Excluding restructuring costs, underlying EBIT grew from -A$50m in FY16 to A$3m in FY17. This was a solid result in our view given the business is also operating in a very competitive market, and while still early days, shows that the transformation strategy is working.
Key earnings forecasts remain unchanged
Given the FY17 result was largely in line with our expectations we have made minimal changes to earnings forecasts at the key underlying EBIT and underlying NPAT levels. While we reduce Coles FY18F underlying EBIT by 11% to A$1,521m due to ongoing competitive pressures, this is largely offset by earnings increases in Home Improvement (+3%), Department Stores (+10%) and Industrials (+12%).
While we view Wesfarmers (WES) as a core portfolio holding, we believe the share price is likely to track sideways over the next 12 months on the back of market concerns around Coles and Bunnings in the UK and Ireland. We expect these concerns will outweigh positive momentum in the other businesses.
We retain our Hold recommendation.
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