Wesfarmers: Still some things to work on

About the author:

Alex Lu
Author name:
By Alex Lu
Job title:
Analyst
Date posted:
20 February 2020, 5:57 PM
Sectors Covered:
Industrials

  • Westfarmers' (ASX:WES) 1H20 result overall was below our expectations.
  • In our view, the key positives were Officeworks (EBIT +4%) and a return to growth in Kmart. The key negatives were Target (where earnings “decreased significantly”) and Industrials (EBIT -21%).
  • The outlook is subdued with management expecting moderated trading conditions in most businesses.
  • We decrease FY20F underlying EBIT by 7% to A$2,878m. Despite a reduction in earnings forecasts, our target price rises to (Morgans Clients can login to view detailed reports and price targets) due to updates to peer multiples and a roll-forward of our model to FY21 forecasts.

1H20 result was below our expectations

WES’s 1H20 result (pre-AASB16) was below our expectations (-4%) at the EBIT level but was in line with our forecast at the underlying NPAT level due to lower net interest and tax. The performance of the operating divisions were mixed with Bunnings (EBIT +3%) and Officeworks (EBIT +4%) delivering growth, while earnings fell in Kmart Group (EBIT -10%) and Industrials (-21%). Earnings were also impacted by A$24m in provisions (A$15m in Industrial and Safety and A$9m in Target) after additional payroll errors were uncovered following further extensive reviews of WES’s payroll systems and processes. WES’s balance sheet remains strong with ND/EBITDA at 0.6 on our calculations, while operating cash flow was down 16% to A$1,666m due to discontinued operations. 1H20 DPS of A75.0cps was in line with our A75.3cps forecast.

Outlook moderated

Management expects moderated trading conditions to continue in Bunnings with further investment in digital and data capabilities. While Kmart remains well-positioned, Target performance is unlikely to improve materially in the near term with ranging remaining an issue. Industrials is likely to remain under pressure while Officeworks earnings growth is expected to slow in 2H20 due to ongoing investment and cost pressures. Overall, we forecast FY20F group underlying EBIT to be down 3% to A$2,878m.

Capital management on the cards?

WES has sold a 4.9% stake in Coles Group (COL), reducing its minority interest to 10.1% and maintaining a board seat. Management said the divestment was in the best interest of shareholders and believe it was an appropriate time to realise value following COL’s strong share price performance (+31%) since its demerger in November 2018. Management has not ruled out returning the proceeds (A$1,050m pre-tax) to shareholders with a decision expected over the next few months.

Maintain Hold

In our view, while WES has a solid portfolio of businesses with strong management teams, the short term outlook remains subdued. With the stock trading on 25.8x FY21F PE and 3.4% yield we continue to see the valuation as full, although the prospect of capital management should see ongoing share price support. We hence maintain our Hold rating with our equally-blended (PE, SOTP, DCF) target price rising (Morgans Clients can login to view detailed reports and price targets).

More information

Morgans clients can login to view our detailed report and share price target for Wesfarmers (WES). Alternatively, please contact your Morgans adviser or nearest Morgans office for access.

Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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