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Date : 05/10/2020

Wesfarmers Limited (ASX: WES)

ASX :

WES

Market Cap : $50.55 Billion

Dividend Per Share : $1.52

Dividend Yield : 3.41 %

Buy

52 Week Range : $29.64 - $49.67

Share Price : $45.26

A low growth firm with stable performances and financial health. We recommend to "Hold" at this price.

Company Analysis

 

Wesfarmers (ASX: WES) is a conglomerate from Western Australia. It is one of the largest companies in Australia. Wesfarmers have a diversified business portfolio. The company generates most of its revenues in Australia, but also operates in New Zealand and the United Kingdom.

The firm operates under the following brands:

  • Bunnings
  • Kmart Group
  • Officeworks
  • Wesfarmers Chemicals, Energy and Fertilisers
  • Wesfarmers Industrial and Safety

Thus, Wesfarmers operates under a lot of different segments and is very well diversified. The segmented performance for FY2020 should give investors an idea as to how weighted each segment.

wesfarmers ltd segmented performance revenues

Company Updates

Wesfarmers is a retail company. Their sales have been affected by the pandemic restrictions that were in play. However, not by much.

Recently, the firm has been restructuring its Kmart segment as it has identified the lack of performance of Target. Wesfarmers is taking measures to increase the performance of the Kmart group by announcing the closure of several Target stores and conversion of several Targets stores into Kmart. This restructuring will bring in impairment costs and restructuring costs in FY2020 and the same has been reflected on the company’s income statement.

Wesfarmers are battling the pandemic restrictions by significantly increasing their digital offerings. Bunnings and Officeworks have seen a growth in demand as work-from-home has become a norm. The retail businesses have been allowed to operate digitally by offering home delivery services through the recent restrictions that were imposed in Victoria.

Wesfarmers has also taken measures to battle uncertainty during the pandemic. 10.1% stake in Coles has been sold off in order to increase its cash position. This sale resulted in over a billion dollars in pre-tax cash. The debt facilities have also been extended to $5.3 billion. Both S&P and Moodys rate Wesfarmers debt as relatively stable with an ‘A- ‘and ‘A3’ credit rating, respectively. This has enabled the firm to increase its debt facilities with relatively low costs of debt.

The company has revealed that it is emphasising on data analytics to better manage inventories during the Covid uncertainty. Data analysis is also sure to benefit the firm to be able to track consumer behaviour and control digital sales.

wesfarmers ltd (ASX:WES) analysis from tradingview.com
Source: Tradingview.com

The essential nature of Wesfarmers products has carried the stock price back up to levels that were seen prior to the crash in March. The firm has benefitted from moving to digital offerings and the same can be seen in its FY2020 financial performance.

Currently, the stock is trading close to 9% off it’s all-time high share price that it was trading at in August. The current price is at levels it was trading just before the March downturn.

Industry Analysis

The segments that Wesfarmers operates are diversified. However, they all have similar industry forecasts. Industries such as Hardware Wholesaling (Bunnings), Retailing (Kmart), etc. are all characterised with low concentration within Australia. The lack of competition makes Wesfarmers a giant, but the industry also has very low growth forecasts.

These are mature industries that are stable. While growth forecasts are not high, the industry is characterised with stable demands – which is extremely important during these turbulent times. The increase in demand for online retailing has meant that businesses will now be prioritising on an online business model to drive sales in the years to come. The performances of the huge number of assets these businesses have will become a question – as assets worth billions of dollars may be subject to decreased performance as the online model predominantly requires just warehouses and delivery trucks.

The average growth forecasts through to 2025 of all industries in Australia that Wesfarmers operates under is just shy of 2%.

Investment Thesis

Wesfarmers has had a strong year with respect to revenues. Its performance has seen a 10% growth over the previous period as it recorded revenues of $30.8 billion. This growth has been mainly led by Bunnings and Officeworks – accounting for 14% and 20%, respectively. Kmart also reported a 5.4% increase from FY2019. The group reported a 60% growth in online sales for the year.

wesfarmers ltd (asx:wes) total revenue from 2016 to 2020

The huge dip in revenues from 2018 onwards is a result of the demerger of Coles from Wesfarmers. The demerger has decreased revenues here, however the profit margins of the firm have increased. EBITDA margins which were hovering around 30% prior to the demerger are now about 37% for the past three years.

The demerger of Coles has not affected the firm’s performance in any way. This is illustrated in the below chart. The return on assets, capital, and equity have all seen increases since 2018. Even though revenues and profits may be down, the returns as a % of assets, equity and capital employed is what matters to ultimately judge performance.

wesfarmers ltd (asx:wes) balance sheet 2015-2020 showing return on assets, capital, and equity

Net income has seen a drop off by 69% compared to the previous financial year. This can be attributed to the restructuring costs and impairments as a result of Target store closures that were mentioned earlier in the report.

The balance sheet of Wesfarmers is enormous. The cash position has been increased to $2.9 Billion to mitigate any unforeseen risks that may arise in these uncertain times. While this alone is not enough to cover all its current liabilities, the total current assets of the firm do offer comfort to investors.

The total assets of the firm exceed total liabilities by 1.5x. The firm does have high levels of debt. The total debt currently stands at $9.8 billion. The firm is heavily capitalised by debt – with the capital structure consisting of 51.4% debt and 48.6% equity. This is slightly concerning given the current uncertainty that the firm and everybody is exposed to. However, given the essential nature of the businesses, the risks can be slightly mitigated as we do not see a huge drop in earnings coming. The credit default risk has been further reduced with the extension of the debt facilities we covered earlier.

financial health of wesfarmers ltd (asx:wes)

Wesfarmers pays 100% franked dividends to its shareholders. The most recent payout being 95 cents with a yield of 3.41%. The total dividend paid out in FY2020 is $1.52 per share. While the dividend payout is high, it is not a very healthy sign for a firm to pay out more in dividends than the income it generates. The retained earnings show a negative $245 million. A concerning sign given the current circumstances. The high dividend relative to its earnings also suggests that the firm is not investing for growth. It is a stable business that is generating stable revenues.

EPS vs dividend performance of wesfarmers ltd (asx:wes) 2015-2020

Our forecast for 2021 is not as high as its performance in 2020. We expect revenues growth rates to be low as consumer demand is set to decline over the better part of FY2021. The recent surges in demand is due to customers spending more time at home – but it does not come with sustainability.

Recommendation

Wesfarmers is a mature company with stable performances. The debt levels of the firm are high, which should cause concern to investors given the risks the markets and consumer demand are exposed to currently. However, the essential nature of its businesses and digital enabled operations reduces risk. The stock is trading close to its highs before the crash in March. We issue investors exposed to the stock to “Hold” as we estimate it to be rightly priced.

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