Wesfarmers: Pullback creates opportunity

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Author name:

By Alex Lu

Job title:

Analyst

Date posted:

18 January 2022, 9:30 AM

Sectors Covered:

Industrials

• Wesfarmers' (ASX:WES) trading update overall was better than we expected despite the group experiencing COVID-related challenges in some of its retail businesses.
• Management has guided to 1H22 NPAT of between A$1,180-1,240m (above MorgansF of A$1,037m but in line with consensus expectations) supported by good results in Bunnings and WesCEF, while Kmart Group and Officeworks were impacted by COVID-related disruptions and costs.
• WES said retail trading conditions weakened in the last two weeks of 1H22 and customer traffic in stores has remained subdued in the first half of January. Staff absenteeism associated with Omicron is having an impact on supply chain productivity and stock availability. These issues are expected to persist while COVID cases remain high.
• We increase FY22F EBIT by 4% to A$3,339m but decrease FY23F and FY24F EBIT slightly (-1%).
• Our target price rises to (login to view) and with a 12-month forecast TSR of 13%, we upgrade our rating to Add (from Hold). We see WES as a high-quality company with a healthy balance sheet and well-regarded management team. Despite short term challenges related to COVID, we think the recent pullback in the share price provides a good entry point for longer-term investors.

Trading update overall was better than expected

WES advised that 1H22 NPAT is expected to be between A$1,180-1,240m (above MorgansF of A$1,037m but in line with consensus expectations) with Bunnings and WesCEF performing well while Kmart Group and Officeworks were impacted by COVID-related disruptions and costs.

Despite guidance at the midpoint implying 1H22 NPAT will be down ~14% vs the pcp, we think this is a decent result after cycling 25% growth in the pcp and the COVID-related disruptions (especially lockdowns in NSW and VIC) during the period. 

Kmart Group was the most impacted

Kmart and Target were significantly impacted by COVID restrictions in 1H22, with almost 25% of store trading days lost due to government-mandated store closures. Trading conditions improved as restrictions eased in 2Q22 but foot traffic was impacted by rising COVID cases in some states, particularly during the Christmas trading period.

WES said while ongoing supply chain disruptions were well managed, there were high levels of COVID-related absenteeism in NSW and VIC distribution centres impacting its ability to deliver stock to stores. This commentary is consistent with several other companies in the market.

Combined Kmart and Target sales fell 10.3% in 1H22 (vs MorgansF -13.2%). However, online sales were strong (+44.2%).

WES expects Kmart Group 1H22 EBIT of between A$170-180m (-64% vs the pcp at the midpoint) with combined Kmart and Target EBIT of A$215m-223m and Catch EBIT of -A$43-45m due to ongoing investment to support growth. 

Changes to earnings forecast

We increase FY22F EBIT by 4% to A$3,339m but decrease FY23F and FY24F EBIT slightly (-1%). For 1H22, we forecast NPAT to be down 15% to A$1,199m (vs management guidance of between A$1,180-1,240m).

Investment view

On the back of changes to earnings forecasts our equally-blended (PE, SOTP, DCF) target price rises to (login to view). With a 12-month forecast TSR of 13%, we upgrade our rating to Add (from Hold).

We continue to see WES as a high-quality company with its share price down 6% over the past month and 15% versus its peak of A$64.98 on 20 August 2021. While not cheap based on FY22 forecasts (30.3x PE and 2.7% yield), the stock looks more attractive on FY23 forecasts (26.7x PE and 3.1% yield). We expect the market will turn its focus to FY23 estimates over the coming months. 

Risks

Downside risks include a decrease in consumer confidence, failure of the retail businesses to adequately follow trends, and inability of management to control costs

Disruptions due to COVID (labour shortages, supply chain etc) remain an ongoing risk. 

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