Wesfarmers Dividend Under Threat?

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

-Returns should improve with re-base
-Dividend yield appealing
-Yet will the dividend be re-based?
 

By Eva Brocklehurst

Wesfarmers ((WES)) has bitten the bullet on retailer Target and its Curragh coal mine, outlining large impairments which will be taken in FY16. The charges do not provide new information, Deutsche Bank maintains, given these two businesses have been operationally weak for some time. While not a positive development, the broker notes the perverse side effect is that returns will improve and profit will lift as a result of a smaller capital base.

Wesfarmers has suggested the impairments will not impact on the company's debt covenants nor the calculation of the final dividend.

Target will make a $50m loss in FY16 from clearance activity and lower gross margins. Restructuring costs of $145m will be incurred, relating to head office, supply chain and inventory. Target will take an impairment of $1.1-1.3bn on its books in FY16. Curragh will incur an impairment charge of $600-850m, driven by a slower-than-forecast recovery in long-term export coal prices and FX.

Otherwise, the medium-term group outlook is considered robust, supported by Bunnings and Coles. Ord Minnett believes these two businesses form the more attractive features of the conglomerate's offering, as well as the company's skilled cash management and a focus on returns. Valuation support is considered modest but the dividend yield and underlying earnings growth are appealing, given the few attractive investment options around.

While larger than expected, Ord Minnett was not surprised by the charges, but raises its rating to Hold from Lighten now the challenges facing resources and Target are well accounted for in the FY16 results. The broker notes early indications of the plan to turn Target around were provided and the discount department store industry is expected to remain aggressive in its clearance activity, adding downside risk to the sector.

Morgan Stanley suspects the next step will be a reduction in Wesfarmers' dividend. The dividend has grown each year since it was re-based to $1.10 in FY09 but the broker expects the weaker resources and Target earnings, as well as the relatively high FY15 pay-out, suggest it may be re-based in FY16. A dividend of $1.80 is forecast, reduced from the $2.00 delivered in FY15.

The broker lowers FY16 earnings estimates by 7.0% to reflect weaker resources earnings and the re-base of Target. Despite this, Morgan Stanley notes the relatively strong outlook for Coles and Bunnings, which now contribute around 80% of group profits. A suspicion that the dividend will be cut is doing the rounds at Citi as well. The broker also suggests the group may be due a downgrade in its credit rating, given funds from operations versus total debt are not improving quickly enough. Citi retains a Sell rating.

Credit Suisse makes no changes to its dividend assumptions and expects Wesfarmers to retain a pay-out ratio close to 100% for FY16. The broker observes most of the charges for Target are associated with the clearance of excess inventory and, therefore, have no negative implications for the business performance in FY17.

Credit Suisse assumes a one-year pay-back on staff redundancy and three-year pay-back on head office closures, implying $40m in cost reductions. There are also no cash flow implications from writing down the carrying value of Curragh and the broker suggests that a change in internal valuation might make for an easier divestment decision.

The performance of Target is disappointing but Macquarie notes the expected loss will be less than 1.5% of FY16 group earnings. The broker observes a positive sales trend across the main retail businesses of Coles, Bunnings and Kmart and retains an Outperform rating.

UBS lauds the company's strategy and market share gains but wonders just how much stronger the top line can grow in a slowing market, and believes it will be increasingly difficult for the company to maintain profitable top line momentum in Coles. The choice management faces, in the broker's opinion, is whether to focus on margin or top line growth in a competitive and deflationary trading environment.

On FNArena's database there is one Buy rating, six Hold and one Sell. The consensus target is $40.58, signalling 1.0% downside to the last share price. Targets range from $37.30 (Citi) to $42.61 (Macquarie). The dividend yield on FY16 and FY17 estimates is 4.8% and 5.1% respectively.
 

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