Wesfarmers Juggles High Expectations

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-Comparable sales seen slowing
-Conditions deteriorating for Coles
-Bunnings the mainstay due to housing
-Stock considered fully valued
 

By Eva Brocklehurst

Wesfarmers ((WES)) produced robust sales numbers across its retail businesses in the March quarter, with the exception of Target, but brokers are mindful of the difficulty in sustaining growth across all divisions going forward. Comparable sales are seen slowing across a number of the businesses, despite being relatively strong in the current economic environment.

Citi expects all divisions will slow down in the June quarter, primarily because of competitive pressures. In terms of Coles, food and liquor growth is expected to slow to 3.0% in June quarter (from 3.4% in March quarter) because Woolworths ((WOW)) will become more promotional.

The broker suspects the competitor did not have time to fix its mistakes in the March quarter and observes more promotions occurred during April. Lower private label pricing and reduced industry-wide food inflation will contribute to weaker sales too. Citi expects the cycle will turn in six months or so for Bunnings and believes Kmart, longer term, needs to develop pricing power. The broker believes high expectations have been built into the company's earnings outlook and maintains a Sell rating. The share performance is linked to Bunnings and Coles and, as Coles' sales slow, there is downside risk over the next three months, in Citi's view.

Conditions are likely to become more difficult for Coles, several brokers agree, as Woolworths redoubles efforts to improve operations. That said, Deutsche Bank does not share the market's structural concerns around the Australian food and liquor retail sector. Sales at Coles were above the broker's expectations, supported by strong contributions from new floor space. Kmart and Officeworks are seen resonating with consumers, while Bunnings should continue to benefit from housing activity. The broker makes modest upgrades to estimates but believes Wesfarmers is fully valued.

Macquarie expects there is further downside risk for Woolworths, as Coles gains market share, but there remains comparable downside risk for Coles, too, as Woolworths steps up investment in price. Nevertheless, Bunnings, Kmart and Officeworks are delivering while a turnaround in liquor and Target is expected to continue. The broker considers Wesfarmers' share price reflects the risks and upgrades to Neutral from Underperform.

Kmart's profit growth in the past was driven by margin expansion so news of like-for-like sales growth of 5.5% was a welcome surprise to Morgan Stanley. The broker expects continuing strong growth as the division's footprint is expanded but would feel more comfortable if management commented on the impact of the lower Australian dollar. Morgan Stanley suspects Coles has taken market share from Woolworths during the quarter but considers space growth has risen to a level which is unsustainable, given the roll-out of competitor stores.

Meanwhile, Target remains a work in progress, in Morgan Stanley's view, with like-for-like sales down 3.2%. Management has suggested unit sales were higher year-on-year but this was offset by price reductions as the brand is repositioned. Credit Suisse agrees Target is the vulnerable division and the strong performance of Kmart signals the difficulty in finding a sustainable growth strategy for both businesses simultaneously.

The broker acknowledges Coles and Bunnings are the more material influences on the company. An increase in packaged grocery deflation could potentially affect Coles but Credit Suisse does not consider the competitive environment is getting worse. As for Bunnings, rapid industry growth is masking any potential adverse effect of store expansion.

To UBS the conglomerate is well run, generating strong free cash flow, but the stock is expensive. The main risk remains a price war in Australian food and liquor, if that was to eventuate. At this stage this is not factored into the broker's forecasts. JP Morgan also finds a lack of compelling valuation support in the stock and only modest upside potential from current levels.

On FNArena's database the stock has six Hold ratings and two Sell. The consensus target is $42.78, suggesting 1.9% downside to the last share price. The dividend yield on both FY15 and FY16 forecasts is 5.1%. 
 

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