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Date : 03/06/2021

Wesfarmers Limited (ASX: WES)

ASX :

WES

Market Cap : $62.80 Billion

Dividend Per Share : $0.88

Dividend Yield : 3.25 %

Hold

52 Week Range : $37.77 - $56.44

Share Price : $56.28

Wesfarmers is a solid performer and a hallmark for stability. We recommend investors to continue to "Hold" on to their positions.

Company Analysis

Wesfarmers Limited (ASX: WES) is engaged in various business operations, such as supermarkets, liquor, hotels, and convenience stores; home improvement; office supplies, and an industrials division with businesses in chemicals, energy and fertilizers, industrial and safety products, and coal. The Company’s segments include Home Improvement; Department Stores; Office Works; Industrials, which includes Resources, WIS and WesCEF, and Other. Bunnings is a retailer of home improvement and outdoor living products in Australia and New Zealand. Kmart is a retailer with approximately 210 stores throughout Australia and New Zealand. Target operates a network of over 300 stores and sells a range of products for the contemporary family, including apparel, homewares, and general merchandise. Officeworks is a retailer and supplier of office products and solutions for home, business, and education. The Company also holds an interest in the Mt Holland lithium project based in Western Australia.

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Source: Wesfarmers

In the face of the pandemic, Wesfarmers demonstrated resilience across its business divisions. Bunnings’ sales grew by 24.3% in the first half of FY21 compared to the first half of FY20, Kmart sales went up by 7.1% while Target and Officeworks saw an increase in sales by 2.3% and 23.6% respectively. On the other hand, the company’s CEF, chemicals, energy, and fertilisers business segment witnessed a decrease in its sales by 6.6% due to the unfavourable economic condition.

A COVID-19 resilient company strengthened by the diversity of operations

For the first time in almost 30 years, Australia was in a recession because of COVID-19. Operating in five different business segments, Wesfarmers has been able to maintain strong performances in these times of global pandemic, where customer shopping and demand is changing. As a diversified large-cap business Wesfarmers owns many of Australia’s most well-known and profitable retail brands. Furthermore, besides the company’s retail cornerstone, WES also owns various other businesses which range from coal mines and lithium processors to clothing lines. We believe in Wesfarmers substantial capabilities for growth through its business approach of expansion via acquisition such as lithium company Kidman Resources (FY2019) and Pilbara Minerals Ltd (ASX: PLS). The company has demonstrated its ability to time well its acquisition regarding anticipation of the rise in demand for electric vehicles (EV) and battery demand.

Less sensitive to the economic cycle and unsystematic risk

Wesfarmers Limited (ASX: WES) portfolio of businesses features five distinct divisions: Bunnings, Kmart Group, Officeworks, Chemicals, Energy & Fertilisers, and Industrial & Safety. Bunnings, Kmart Group and Officeworks divisions had a strong revenue increase and have been profitable. However, the Energy and Industrial & Safety division performed poorly because of lower customer demand and lower prices which are resulting from the global pandemic of COVID-19. Yet the overall company revenues and net profit after tax are respectively 10.5% and 16.4% from the previous period. We think that Wesfarmers is in the long-term a guarantor of stability as its assets are spread in the cyclical and non-cyclical sector. Therefore, the company can generate revenues regardless of the economic cycle.

Wesfarmers continues its expansion from retail, EV to digital

With its strong balance sheet and wide range of cash-generative businesses, WES is well-positioned to deal with a range of economic conditions and to continue to expand. Moreover, Wesfarmers Limited has demonstrated its skills in making successful earnings accretive acquisitions, such as recently the lithium business Kidman Resources which can position ASX: WES in the upcoming EV industry boom with battery production. The group has also been investing in the development of digital platforms over the last two years to cope with the change in customers’ consumption habits. Lockdown measures have considerably reduced traffic in retail stores. In 2020, Wesfarmers e-commerce sales were A$ 2 billion, or 7% of the company’s total sales. And the digital economy is expected to grow by 15.8% CAGR from 2020 to 2023, which bodes for better days for the company’s future revenues.

Company Updates

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Source: Tradingview.com

ASX: WES solid trading performance in the group’s retail businesses during the first half of FY21 reflected the ability of the company to constantly adapt to changing customers’ demands. The company exhibits a strong operating result as well with WesCEF and the industrial and safety business segment which registered an improvement in the performance of Blackwoods resulting in an increase of +25.5% year-over-year in NPAT excluding significant items to A$ 1,414 million. Wesfarmers also reported solid growth in sales in Bunnings and Officeworks, induced by the increase in demand for products due to COVID-19 lockdowns which prompted customers to spend more time working from home. WES has demonstrated its capabilities to adapt to a challenging economic environment and the COVID-19 restrictive measures which weighed significantly to the brick-and-mortar retail sector by developing its online presence. Hence, WES online sales surged by 125% for 1H21 to A$ 1.4 billion or A$ 2 billion including the Catch marketplace. Wesfarmers free cash flows increased significantly by +4% year-over-year.

Bunnings and Officeworks

The economic outlook for FY21 remains uncertain and is affecting the retail sector. However, Bunnings and Officeworks sales performance are expected to continue to benefit from consumers spending during the imposed COVID lockdowns. Sales and earnings growth are likely to remain moderate as the business begins to cycle the initial impacts of the COVID-19 of FY20. Furthermore, Wesfarmers continuously focus on long-term investment to broaden its commercial markets, its digital capabilities and strengthen its online and in-store offers.

Kmart

Wesfarmers continues to invest in the enhancement of Kmart’s customer offer including new in-store retail technology and the development of data and digital capabilities. During FY20, the company has well progressed on actions to accelerate the growth of Kmart and had optimised the Target store network by converting 12 large format Target stores to Kmart and 7 target country stores to new K Hub small format. Wesfarmers also introduced Kmart products to the Catch Marketplace and accelerated the investment in marketing which saw an increase of 0.6 million active customers during the first half of FY21 with a total of 2.9 million on December 31, 2020.

Chemicals, Energy and Fertilisers

The production and demand for Ammonium Nitrate are likely to remain stable throughout FY21. COVID-19 has disrupted activities at gold mines hence demand for sodium cyanide is expected to remain weak at least to the second half of 2021. Wesfarmers is investigating opportunities to expand its Sodium Cyanide production for export to anticipate the reopening of the economy and the surge in the global demand for gold. FY21 may witness an increase in competitive pressures in the Western Australian fertiliser market which may impact WES fertilisers earnings. Earnings are likely to continue to be impacted as well by the international commodity prices, exchange rates and seasonal outcomes.

WES earnings will depend on the pace of the economic recovery during FY21

The Economic conditions in Australia have recovered strongly since the end of FY20 and the outlook is more positive, however, uncertainty remains high subject to forthcoming COVID-19 risks. WES sales in the retail business segment have continued to remain strong through January and February, with some impact from government-mandated trading restrictions. Customers spending extra time in Home due to imposed lockdowns will likely support higher demand across the WES retail segment. Hence, retail sales growth is projected to be restrained from March as the businesses begin to cycle the initial impacts of COVID-19 of FY20, predominantly in Bunnings and Officeworks. FY21 performance of WES industrial business segments are likely to be impacted by commodity prices, foreign exchange rates and seasonal outcomes. Furthermore, Wesfarmers is incurring additional costs of approximately A$ 10 million per quarter to provide a COVID-safe environment. The company’s portfolio of cash-generative assets is well-positioned to navigate through the economic challenges throughout FY21 and deliver solid returns over the long term.

Industry Analysis

Demand for home improvement to remain steady

Australian bushfires and COVID-19 had a considerable impact on sales in the home improvement and lifestyle segment. Following stay at home restrictions, demands for home improvement products as well as office supplies such as computers and stationery increase; hence Bunnings and Officeworks increase in revenues.

The energy sector to gradually rebound on the expected lift of travel bans

Travel bans have impacted the energy sector with grounded planes and ships docked which triggered a decline in crude oil demand. According to the Independent Commodity Intelligence Services (ICIS, 2020), energy demand is expected to be linked to coronavirus restrictions. As vaccination programs roll out, borders could be reopened, hence, the energy demand is expected to recover gradually.

Fertilisers demand to remain in line with the average 1% annual population growth rate of Australia

The demand for fertilisers is correlated to the food production output which is linked to population growth. According to Statista (2021), the Australian and New Zealand population is expected to grow annually between 0.9% and 1.4%.

Unprecedented demand for protective equipment amid COVID-19 crisis

The industrial and safety workwear sector has seen an unprecedented demand for personal protective equipment (PPE) since the beginning of the pandemic. The increasing demand in PPE offset the demand for other workwear which has declined because of factory closure and stay-at-home measures.

Wesfarmers has a diversified quality portfolio of brands and businesses. We believe the group is well-positioned for growth over the long term and is less likely to suffer from the economic cycle thanks to its diversified balance sheet.

Investment Thesis

Financial Performance: Strong start of FY21 despite ongoing uncertainty

Despite the challenges caused by the pandemic, Wesfarmers maintained solid performances, increasing revenues, and growing EBIT. With the COVID-19 vaccines roll out, the company will reduce its exposure to supply chain risk and hence its production costs. Yet the company can leverage its new capital structure to further reduce its expenses and boost its liquidity. The expansion and diversification strategy positions Wesfarmers as a cash machine resilient to systematic risk. We are hopeful that demand in declining sectors will recover as stay-home restrictions are lifted. Therefore, we believe that WES operating performance will be in the meantime, in line with the investor’s expectations for FY21.

Wesfarmers offers solid dividends supported by strong fundamentals.

Operating cash flows increased by more than 16% during the first half of FY21 stimulated by strong divisional earnings growth. Cash generation remains solid across business divisions despite the economic uncertainty. Wesfarmers reported a divisional cash generation of 111% slightly below the threshold of the last five-year first-half average of 125%. With operating cash flows that increased by 4% during the period, the company was able to comply with their dividend distribution policy which offered a fully franked half-year ordinary dividend of A$ 88 cents per share. The first half of FY21 dividends slightly increased from the FY20 interim dividend, however, the recently declared dividend remains below the one-dollar interim dividend of FY19.

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Source: Wesfarmers

The first half of FY21: Strong sales and earnings growth

Wesfarmers delivered strong sales and a surprising earnings growth with an NPAT of A$ 1,414 from continuing operations which represents a 25.5% growth year-over-year. Bunnings, Kmart, and Officeworks reported strong trading results, demonstrating the capabilities of Wesfarmers to adapt to the changing business environment. WesCEF, Chemicals, Energy and Fertilisers division reported solid operating performance.

Sales growth has been mainly contributed by Bunnings and Officeworks which was mainly boosted by the stay-at-home order. Conversely, due to the impact on the economic environment, Wesfarmers’ chemicals, energy, and fertilisers segment performed poorly and declined by -6.6%. Surprisingly, Kmart, Target and the industrial and safety segments performance remained in line with 1HFY20 results. Wesfarmers sales performance reflects a resilient business capable of sustaining in various economic cycles. More importantly, we have recognised that Wesfarmers has a sustainable revenue growth with a consistent improvement year-over-year of the profit margin. Gross profit margin is projected to grow by a CAGR of +29% by the next 3 years, while net profit margin is planned to tremendously improve with 69% CAGR from FY20 to FY23.

Strong balance sheet as a result of solid cash flow performance

Wesfarmers has maintained a strong balance sheet supported by its solid cash flow performance and the actions taken in the FY20 in response to the uncertainty associated with COVID-19. The Group reported a net cash position of A$ 871 million at the end of the first half of FY21. Despite an apparent increase in debt as attested by a slight increase in weighted average cost of debt to 4.38% in the first half of FY21 compared to 4.25% in 1HFY20 due to a shift in the debt mix toward higher-cost bonds, the company’s finance costs decreased by 13% to A$ 60 million in during the period compared to A$ 69 million in 1HFY20. Wesfarmers exhibits a solid balance sheet via its diversified cash-generative assets which allowed the group to repay domestic bonds worth A$ 500 million.

Liquidity & Rating

Since the last 3 years, Wesfarmers continuously improved its liquidities as attested by the company’s quick ratio of 0.58 in FY20 compared to 0.40, 0.27 and 0.30 in FY19, FY18 and FY17, respectively. The current ratio is also indicating a solid capital structure. Wesfarmers displays strong credit metrics and a stable outlook rating with Moody’s attributing a rating of A3 and Standard & Poor A-.

FY17 FY18 FY19 FY20 TTM
Quick Ratio 0.30 0.27 0.40 0.58 0.46
Current Ratio 0.93 0.87 1.22 1.11 1.01

Wesfarmers FY21 P/E ratio is estimated at 27.7 times which is slightly above the industry’s price to earnings ratio at 20.5 times. Furthermore, since FY17, the company’s assets have continuously declined, down -36%. On the other hand, liabilities increased during FY19 and FY20, from 22.8% to 31.6% of the company’s capital structure mix. Hence, with the recent earnings growth and a declining asset, we believe Wesfarmers to be fairly valued at its current market price.

FY18 FY19 FY20 FY21E FY22E FY23E
P/E ratio 46.7x 7.43x 29.9x 27.7x 27.1x 26.0x
EV/REV 0.90x 1.55x 1.87x 2.10x 2.08x 2.01x
EV/EBITDA 10.8x 12.3x 13.5x 13.6x 13.6x 13.1x
P/B ratio 2.45x 4.10x 5.43x 6.55x 6.34x 6.10x

Recommendation

Wesfarmers reported solid revenues across its business segments during the first half of FY21. We think that Wesfarmers is in the long-term a guarantor of stability as its assets are spread in the cyclical and non-cyclical sector. Therefore, the company can generate revenues regardless of the economic cycle. The outlook for the company’s price to earnings (as of 3-Jun-21) is projected to be slightly above its industry’s ratio, hence we can conclude that WES is currently fairly valued at its current market price. We are issuing a “Hold” recommendation on Wesfarmers.

 

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