Wesfarmers: Biting the bullet

About the author:

Alex Lu
Author name:
By Alex Lu
Job title:
Analyst
Date posted:
25 May 2020, 10:45 AM
Sectors Covered:
Industrials

  • Wesfarmers (WES) has provided an update on the strategic review of Target with initial actions including the conversion of some Target stores to Kmart stores, the closure of a number of Target stores and a significant reduction in store support costs.
  • The restructure of Kmart Group will incur one-off costs (pre-tax) of A$550-650m in FY20 and A$120-140m in FY21. WES will also book a A$300m charge (pre-tax) for the impairment of goodwill in the Industrial & Safety division due to the deterioration in economic conditions and uncertain outlook.
  • We adjust FY20F/FY21F/FY22F underlying EBIT by -1%/-1%/0%. Maintain Hold rating on a slightly higher target price (Morgans clients login to view).

Shrinking the Target store network

WES has provided an update on the strategic review of Target including changes to the Target and Kmart store networks. The changes are intended to improve the performance of Target while continuing to strengthen Kmart and the digital offering as customers increasingly prefer to shop online.

Actions include:

  1. the conversion of 10-40 large format Target stores to Kmart;
  2. conversion of ~52 Target Country stores to small format Kmart stores;
  3. closure of 10-25 large format Target stores and 50 Target Country stores;
  4. significantly reducing the size of the Target store support office.

These changes are expected to happen over the next 12 months with the majority occurring in CY21. WES will provide a further update on the Target strategic review at the FY20 result in August.

One-off costs likely to be over A$1bn

The restructure of Kmart Group will incur one-off costs (pre-tax) of A$550-650m in FY20 and A$120-140m in FY21. These relate to store closure costs, inventory write-offs and the reduction in store support costs as well as impairment charges related to the Target brand, PP&E and capitalised leases and other assets.

WES will also book a A$300m charge (pre-tax) for the impairment of goodwill in the Industrial & Safety division due to the deterioration in economic conditions and uncertain outlook.

Minor changes to earnings forecasts

We decrease underlying EBIT by 1% in both FY20F and FY21F mainly due to the weaker outlook for the Industrial & Safety division. At this stage our Kmart Group forecasts remain broadly unchanged in FY20F and FY21F given the majority of the restructure will occur in CY21.

We also assume that the positive impact from the closure of loss-making Target stores and reduced store support costs will be offset by store conversion disruption and increased investment in digital.

We expect greater benefits to flow through from FY22.

Maintain Hold rating

Target has been an underperformer for many years and previous attempts at kickstarting the business have not worked.

Given Kmart's position remains strong we think the move to accelerate its expansion while significantly reducing the Target network makes sense. We believe a greater focus on online is also the right move as customers will likely continue to prefer this channel due to COVID-19.

Despite minor reductions in earnings forecasts our equally-blended (PE, SOTP, DCF) target price rises (login to view) as we expect the Kmart Group restructure to provide longer-term benefits.

While we continue to see WES as a well-managed, diversified company with a strong balance sheet, trading on 22.8x FY21F PE and 3.9% yield, we view the current valuation as fair.

More information

Morgans clients can login to view our detailed report and revised share price target for Wesfarmers. 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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