Wesfarmers Overpriced Says Credit Suisse

This story features WESFARMERS LIMITED, and other companies. For more info SHARE ANALYSIS: WES

By Chris Shaw

While the market has rallied in recent weeks, Credit Suisse argues the rally in Wesfarmers ((WES)) shares has gone beyond what can be justified by the performance of the discretionary retail and resource sectors, which in the broker’s view has created a selling opportunity in the stock.

On its numbers the shares are two standard deviations more expensive relative to an equivalent portfolio that could be constructed from the likes of Woolworths ((WOW)), Harvey Norman ((HVN)), JB Hi-Fi ((JBH)), Centennial Coal ((CEY)), Coal & Allied ((CNA)) and Felix Resources ((FLX)), so an alternative would be to switch to being short of Wesfarmers and long such a portfolio.

The broker’s view is not changed by increases to its earnings forecasts through to FY11, which largely reflect the impact of better assumed discretionary retail numbers. The changes see the broker forecasting earnings per share (EPS) of 174.4c this year, 122.5c in FY10 and 151.3c in FY11. The FNArena database shows consensus forecasts for FY09 and FY10 of 175.5c and 120.9c respectively.

Credit Suisse’s earnings forecasts imply a valuation on the stock of $18.72, while the broker’s price target has risen to $20.00 from $17.00 previously post its estimate changes. But as the broker notes, the current share price implies an additional $6.7 billion in value, which equates to additional earnings before interest and tax of as much as $800 million. 

Credit Suisse does expect improved performance from Coles, but the broker sees the future improvement as being a steady change rather than a step change, as the current high level of capital investment and competitive pricing that is needed to lift performance will also hold back earnings growth to some extent.

This means the additional value being priced in by the market is difficult to justify as even under a bull scenario the stock is trading on 15.9x FY11 earnings compared to a 13x average for the major discretionary retailers and an average of 12x for comparable coal producers.

The broker is not alone with its Underperform rating on Wesfarmers with Bank of America Merrill Lynch also having an Underweight recommendation, while the FNArena database shows a total of four Buys, three Holds, one Reduce and the two Sells.

The average price target on Wesfarmers is $23.23, up from $22.89 on the back of the increase in Credit Suisse’s target. Deutsche Bank leads the way with its $30.00 target, having upgraded the stock to a Buy last week on the view a turnaround in performance at Coles is underway and this has positive implications for earnings going forward. Bank of America Merrill Lynch is the low marker with a target of $16.50.

Shares in Wesfarmers today are unchanged as at 11.45am, the stock last trading at $26.22. This compares to a range over the past year of $14.81 to $36.00.

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