Wesfarmers: Rolling with the punches

About the author:

Author name:

By Alex Lu

Job title:

Analyst

Date posted:

18 February 2022, 7:00 AM

Sectors Covered:

Industrials

• Wesfarmers' (ASX:WES) 1H22 result was largely in line at the underlying NPAT line (+1% vs MorgansF), which was not a surprise with guidance provided in January. However, the result was weaker (-5% vs MorgansF) at the underlying EBIT line.
• Key positives: ROE (rolling 12m) was up 10bp to 24.8%; 1H22 DPS of 80cps was above our 74cps forecast.
• Key negatives: Weaker than expected earnings from most divisions; Operating cash flow fell 30% due mainly to higher inventory; Supply chain disruptions, higher transport costs and labour constraints are expected to persist in 2H22.
• We decrease FY22-24F underlying EBIT by 2% in each year.
• Our target price decreases to (login to view) and we maintain our Add rating. Despite ongoing uncertainty in the operating environment, we think WES is well-placed to benefit when conditions improve and continue to view the stock as a core portfolio holding for long-term investors.

1H22 result summary

1H22 underlying EBIT (incl. interest on leases) fell 13% to $1,796m (-5% vs MorgansF) and underlying NPAT decreased 14% to $1,213m (+1% vs MorgansF). Earnings in all retail divisions were lower (Bunnings EBIT -1%; Kmart Group -63%; Officeworks -18%) while WesCEF EBIT jumped 36% and Industrial & Safety rose 11%. 

Group EBIT margin dropped 150bp to 10.1%, impacted by the extended lockdowns in NSW, VIC, ACT and NZ during the half, supply chain constraints and labour shortages. WES also incurred additional costs related to cleaning, security and PPE (~$43m) as well as paid its employees pandemic leave (~$37m) through periods of the prolonged lockdowns.

Retail divisions disrupted by COVID

Bunnings continues to perform well with EBIT down only 1%. While the result was 8% below our forecast, it was nonetheless a good outcome following 36% growth in the pcp. LFL sales rose 1.5% (1H21: +27.7%) with lockdowns and store closures negatively impacting sales in 1Q22 before a strong rebound over the Christmas trading period.

Bunnings completed the acquisition of Beaumont Tiles during the half which will further enhance its trade offering and complements the purchase of Adelaide Tools (now rebranded to Tool Kit Depot) in FY20. For FY22, we forecast Bunnings EBIT to be up 2% to $2,220m. 

Kmart Group EBIT fell 63% to $178m, which was in line with management’s guidance of between $170-180m provided in January. As previously flagged, the division was heavily impacted by government-mandated store closures, although performance improved in 2Q22 as restrictions eased.

With management expecting the short-term outlook to remain uncertain and volatile, we forecast FY22 Kmart Group EBIT to be down 53% to $325m. 

Officeworks delivered a weak result with EBIT falling 18% to $82m (-11% vs MorgansF). While sales rose 4%, there was an adverse mix impact from lower sales in the higher-margin office supplies and print & create categories.

Higher COVID-related costs (including government-mandated store closures) and ongoing digital investment also affected margins. Management expects the short-term outlook to remain challenging with the business to continue to incur higher costs. For FY22, we forecast Officeworks EBIT to fall by 17% to $176m.

Outlook

WES said retail trading conditions were subdued in January due to Omicron but momentum has improved in recent weeks. However, supply chain disruptions, elevated transport costs and labour constraints are expected to continue in 2H22.

Overall, we forecast FY22 group underlying EBIT to fall by 8% to $3,257m.

Changes to earnings forecasts and investment view

We decrease FY22-24F underlying EBIT by 2% in each year. 

Our equally-blended (PE, SOTP, DCF) target price falls to (login to view) and with a 12-month forecast TSR of 18%, we maintain our Add rating.

We view WES as a core portfolio holding for long-term investors with a diversified group of retail and industrial brands, solid balance sheet and strong leadership team that will continue delivering value for shareholders.

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