Wesfarmers Upholds Resilient Outlook

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

-Bunnings resilient to housing downturn
-Coles likely winning share
-But food deflation accelerates
 

By Eva Brocklehurst

Conglomerate Wesfarmers ((WES)) sustained a strong September quarter for its retail businesses. Brokers note even Target, which has struggled for some time, appears to have turned around.

Overall, sales grew by 6.5% ex petrol, and this should allow Wesfarmers to invest in prices and maintain healthy margins, Deutsche Bank maintains. Home improvement (Bunnings) impressed the broker as that division's sales rose 8.2%, cycling similar growth in the prior corresponding quarter.

Percentages may ease in future, the broker suspects, given the level of market penetration. Trade accounts appear to be making up a larger proportion of sales at Bunnings now and this suggests to Deutsche Bank the business could become more volatile.

What about the slowing housing construction outlook? Brokers are not that perturbed, given the market share Bunnings holds. Credit Suisse suspects the future of competitor Masters, owned by Woolworths ((WOW)) is the main variable for Bunnings.

The broker suspects closure of the Masters chain would be a benefit to Bunnings, while a change in ownership and strategy on the back of an exit by Woolworths could produce the reverse. Macquarie dismisses the slowing housing outlook, citing the resilience of Bunnings and lack of competition if Masters is wound up.

A new spurt of growth was evident at Kmart, as the chain expands its range. Citi suspects one third to half of the Kmart sales growth in the quarter emanated from the problems that competitor Big W (owned by Woolworths) endured in its inventory systems.

Target also recorded its first quarterly sales growth in several years, with fewer mark downs in the quarter. Credit Suisse considers this development validates the re-positioning of the Target image. While it is early days, Deutsche Bank also believes Target is showing promising signs.

Meanwhile, food price deflation has increased to 1.3% in the quarter, its highest rate in two years, which highlights the prospect that profit growth is slowing for Coles. In the absence of sales figures from Woolworths, Deutsche Bank highlights the difficulty in determining the extent to which Coles has outperformed.

Still, there are signs Coles gained considerable market share in the quarter. Morgans is confident Coles is winning the battle in the supermarket arena and it should deliver reasonable sales growth, even during a period of structural change and competition in the industry.

Brokers also believe the performance of Coles has been boosted by the weak performance of Woolworths. The higher level of price deflation signals the likelihood that margins will continue to compress across the supermarket industry as players increase their levels of price investment. In this regard, Morgan Stanley forecasts Coles earnings margin to compress to 4.7% in FY20 from 5.4% in FY15.

Goldman Sachs makes the observation that there was no comment from Wesfarmers on the impact that price competition was having on margins. Downside risks that Goldman Sachs contemplates include a resumption of "price wars" in groceries and a successful turnaround for Masters.

Goldmans, not one of the eight brokers monitored daily on the FNArena database, has a Buy rating and $50.50 target for Wesfarmers.

Most brokers expect the slowdown in two key divisions – food and home improvement – will limit upside for the share price. Several consider Wesfarmers a good business with strong management but fair value.

JP Morgan believes the modest valuation support and no imminent change in the portfolio, with a lack of impetus in the industrial divisions, means the share price is likely to remain range-bound.

Citi suspects that some of the sales growth in the quarter is largely a reflection of less stable rivals. The broker questions the price being paid for Wesfarmers' growth and sticks with a Sell rating.

Morgans, on the other hand, believes the premium to Woolworths is entirely justified and the stock offers an attractive mix of reliable earnings growth and yield. Hence the broker retains an Add rating.

FNArena's database has two Buy ratings, six Hold and one Sell with a consensus target of $41.74, suggesting 0.4% downside to the last share price. Targets range from $35.80 (Citi) to $45.08 (Macquarie). The consensus dividend yield on FY16 and FY17 is 5.0% and 5.3% respectively.
 

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