Brokers Remain Unsure On Wesfarmers

This story features WESFARMERS LIMITED. For more info SHARE ANALYSIS: WES

By Andrew Nelson

It looked like a pretty solid set of first quarter numbers and investors loved it, with the share price rallying 8% to its highest level in more than a year on Friday. Yet whether they like Wesfarmers ((WES)) or not, analysts seem to have maintained their reservations about the stock post the quarterly update.

Despite the positive quarterly sales performances across most businesses likely to maintain the improved sentiment in the weeks ahead, the stock currently rates a 0.0 on the FNArena Sentiment Indicator. There are 2 Buys, 5 Holds and 2 Sells among the brokers in the FNArena database. Friday’s closing price was just over 4% above the average target price from these 9 brokers.

Looking at the result, the company reported a 6.1% first-quarter rise in its retail sales, which was not only ahead of market expectations but was also well above retail rival Woolworths’ quarterly sales growth of 4%. What the market probably liked best was the performance from Coles, which booked a 7.3% rise in total food and liquor sales for the quarter, while comparable store sales (known as comps, which cover stores open at least one year) were up 6.1%.

However BA-Merrill Lynch, who is negative on the stock, points out some key problems with the numbers. Wesfarmers didn’t disclose the absolute dollar amount of sales for either this quarter or the first quarter last year, and without knowing the extent of profit improvement at Coles relative to the sales growth, its impossible to tell how good this result really was.

Secondly, notes the broker, this was just one good quarter. Yet to be of any real help to Wesfarmers, Coles needs to deliver sustainable earnings growth. This will be tough to do, thinks the broker, given that product price inflation is falling fast and Woolworths is spending up big on store presentations and customer loyalty. Yet at the end of it all, the broker summed up the result from Coles as “very impressive” despite its reservations.

In addition, Bunnings reported robust comps growth of 15%, with Merrill’s saying the division looks to have “an impregnable market position that is getting stronger”. Not a bad rating from a broker with an Underperform call. Officeworks also looks like it is turning a corner, with a 12% increase in quarterly comps achieved. However, comps at clothing and housewares group Target were up only 1.8%, while for Kmart, which is the middle of a transformation program, sales were down 2.3% for the first quarter. So its not all retail roses for the Group.

The group’s coal business is also expected to do a bit better than previously thought, with production in-line so far. Going into the financial year the division was expected to have to wear what were looking to be materially lower coal prices and higher costs. Yet even Merrills thinks the group’s Coal business will be profitable in FY10, saying the future looks “very positive”, with higher prices and volumes and improved costs supporting profits, sharing the view held by those brokers that are positive on the stock.

Yet despite the positive view on a number of key segments of Wesfarmers, Merrills has stuck with its Underperform call on valuation grounds, while also citing risks in volatile coal prices, the possibility of waning consumer sentiment and the lack of sustainability in the Coles turnaround story.

Credit Suisse is the other broker with an Underperform rating on the stock and its reaction to the report was fairly positive as well, despite initially calling it “mixed”. From a broker who had always felt that a Coles turnaround was the key for re-rating, one might have expected a better rating than “mixed”, especially given the broker suggests Coles is now “showing signs of having stabilised and a steady increase in earnings now appears more likely than not”.

The broker was also positive on Bunnings, not worried by Kmart’s slow going and even saw upside in the group’s insurance business going forward, despite less than impressive numbers for the quarter. It seems the broker’s main problem with the stock is a “less than exciting outlook for industrial businesses”, Credit Suisse also thinks the recent appreciation in the AUD could do some serious harm to the group’s resources earnings in FY10. And when the broker adds these factors into its modelling, it believes “the earnings outlook is more sobering” than many are factoring in.

That said, the broker admits that an overall improvement in discretionary spending, increasing housing activity and an improving outlook for coal prices does put some upside pressure on its $25.00 price target. But given that the shares closed more than $2.00 above that target on Friday, that call has already been justified.

UBS, who is Neutral on the stock, thought Friday’s 8% rally was overdone. While the numbers from Coles were a “positive surprise”, much like Merrills UBS thinks one good quarter does not a turnaround make. On top of that, the broker cut forecast FY10 EPS by 6.3% on the stronger AUD while noting that in its view, coal is the wild card for the group. The broker notes the potential for much better prices, but also some serious AUD risks and stubbornly high costs.

RBS and Citi have also sat on their respective Hold calls despite being fairly upbeat about not only the retail performance, but also about the coal outlook. Citi says “demand and supply factors are supportive of higher coal prices”, while RBS notes the improvement in demand for coal, particularly metallurgical coal, should translate into stronger volumes and prices in 4Q10. In fact, RBS goes so far as to say that the group’s Resources division should double its FY10 profit in FY11.

But for both of theses brokers, much like Credit Suisse and Merrills, valuation is still the major issue. And while Citi tacked almost $2.00 on to its price target today, the end result was a target that was still shy of Friday’s share price. As at 11:43 this morning, shares in Wesfarmers were down 23c at $28.03, but still not too far from the top end of the 12 month trading range of $14.810 – $28.54.

Click to view our Glossary of Financial Terms