Can Wesfarmers Continue To Outperform?

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

– Analysts attended a Strategy Day organised by Wesfarmers
– Coles turnaround is expected to continue
– Some issues at Target and in coal operations
– Bunnings faces some challenges
– Neutral views on stock continue to dominate

By Chris Shaw

A strategy day from Wesfarmers ((WES)) provided some insights into how management intends to continue delivering growth in coming years, but it was not enough to shift brokers from essentially neutral views on the stock at current share price levels.

As Citi notes, the update showed management at Wesfarmers continues to be excellent but this is not enough to allow the company to beat the consensus earnings outlook. This reflects the fact while Coles will continue to lift performance, Target's position is being re-set, which implies another 18 months or so of falling comparable store sales. As well, JP Morgan is cautious on the outlook for Bunnings given a number of headwinds including a weak consumer and housing environment and stronger competition.

For Coles, JP Morgan suggests there continues to be growth opportunities from strengthening the loyalty program, not only in converting additional customers but in improving sales per square metre from better utilisation of store space.

With respect to Target, BA Merrill Lynch suggests the new management team appears to take the view a heavy restructuring is needed, this despite the broker's view the business is not broken. Coal division earnings are also an issue for BA-ML given more bearish expectations with respect to operating costs and a sustained lower quality mix of coal being produced.

Post the update from management there have been relatively minor changes to earnings estimates across the market, UBS trimming its earnings per share (EPS) forecasts by 1-2% and RBS Australia adjusting its numbers by a similar magnitude. Consensus EP estimates for Wesfarmers according to the FNArena database are 184.2c for FY12 and 203.3c for FY13.

On UBS's numbers, Wesfarmers is likely to generate three-year capitalised annual growth in earnings of around 6%, or 9% ex-resources. Despite this modest growth, the stock is trading on a forecast 14 times earnings in FY13, which is a solid premium to the market.

To deliver share price outperformance from current levels UBS suggests positive earnings revisions are required, something that doesn't appear likely given retail sales are being constrained by deflation and there are rising cost pressures across the businesses of Wesfarmers.

JP Morgan is similarly cautious, noting while the Coles turnaround remains on track, there is potential for slippage in the rate of earnings growth over the short to medium-term. Add in increasing competition for Bunnings and the implication is there is some short-term downside risk for Wesfarmers shares.

Most of the brokers in the FNArena database agree, as Wesfarmers is rated as Hold six times, compared to one Buy and one Sell recommendation. The exception on the Buy side is BA-ML, who argues there continues to be material upside potential in Coles from operational improvements and efficiencies, while Bunnings should continue to grow via an increased store footprint.

Goldman Sachs is not in the FNArena database but also rates Wesfarmers as a Buy, this on the expectation the key Coles food and liquor operations continue to deliver strong earnings momentum thanks to continued improvements within the operations. Post the update, Goldman Sachs has added Wesfarmers to its Conviction Buy list.

At the other end in terms of ratings sits RBS Australia, who maintains a Sell call on Wesfarmers given at current levels the market appears to be overlooking relative earnings cyclicality and is not pricing the stock for the potential to miss on what are high earnings expectations. 

RBS's Sell rating is accompanied by a price target for Wesfarmers of $26.20, which is comfortably the lowest in the database. Targets range as high as BA-ML at $33.00, the consensus target standing at $29.71. This is down slightly from $29.91 prior to the investor day update. Goldman Sachs has a target on Wesfarmers of $39.78.

Shares in Wesfarmers today are stronger despite a weak overall market and as at 12.00pm the stock was up 13c at $29.08. Over the past year the stock has traded in a range of $26.04 to $33.38, the current share price implying upside of around 2% relative to the consensus price target in FNArena's database.

 
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