Wesfarmers Update Sees Expectations Lowered

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

– Brokers trim forecasts post Wesfarmers site visit
– Price targets also come down
– USB downgrades to Neutral rating

By Chris Shaw

Industrial conglomerate Wesfarmers ((WES)) last week held a tour of its Chemicals, Fertiliser and Energy business, the update giving additional insight on three main points. One was challenges with respect to LNG and LPG projects giving rising gas prices and falling LPG content, another the expansion plans for ammonium nitrate and the final an update on earnings guidance for the division.

Stockbrokers left the tour with a somewhat mixed view on the earnings outlook for Wesfarmers, with forecasts being adjusted accordingly. The changes to views are summed up by UBS trimming earnings per share (EPS) forecasts by 6.4% for FY12 and by 1-3% in later years to reflect a likely deterioration in margins for the division in coming years.

The other factor impacting on group earnings overall for UBS was the factoring in of lower operating leverage in the Coles business, this due to continued price deflation. Others in the market have reacted in a similar way, with JP Morgan lowering its numbers by 2.5-3.5% through FY14, while Citi has been more aggressive in cutting its numbers by 7.5% this year and by 4.6% in FY13.

Citi's numbers come down to reflect lower forecasts for Coles, as like UBS the broker sees fresh produce price deflation as still an issue. As well, comparable store sales are expected to slow, while there have been some teething problems with respect to new supply chain practices.

The cuts by Citi also reflect lower hard coking coal price forecasts, this to account for slower global growth expectations and ongoing domestic cost pressures. This is significant for earnings at Wesfarmers, as Citi estimates every US$10 per tonne move in met coal changes pre-tax profit by 2.3%.

Consensus EPS forecasts for Wesfamers according to the FNArena database now stand at 206.5c in FY12 and 230.1c in FY13. This compares to the 166.3c recorded in FY11. New earnings estimates mean new price targets, with the FNArena database showing a consensus target now of $32.75. This is down from $32.94 previously.

For UBS the changes to its numbers are enough to downgrade to a Neutral rating on Wesfarmers, from Buy previously. In the broker's view the outlook for the company remains favourable, but this is reflected in the stock trading around fair value at current levels. 

This changes what had been an equal weighting between Buy and Hold recommendations, as the database shows Wesfarmers is now rated as Buy three times and Hold five times. 

The Buy argument for Wesfarmers continues to be supported by JP Morgan. The broker continues to see longer-term upside from an ongoing turnaround at Coles, as well as Kmart and Officeworks, strong resources demand and solid results from Bunnings.

Citi sides with UBS and rates Wesfarmers as Neutral, suggesting while a further two years of double-digit earnings growth is likely this is reflected in a high earnings multiple at current levels. This argument is taken further, Citi pointing out if the retail operations of Wesfarmers are assessed separately, these businesses are trading on a much higher multiple than retail peers This implies a turnaround at Coles is being priced in by the market.

Shares in Wesfarmers have traded in range over the past year of $26.04 to $35.26. The current share price implies upside of around 6% to the consensus price target in the FNArena database. 

 

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