Wesfarmers Nets Catch Group

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Online retailer Catch Group is the purchase of the day for Wesfarmers, expected to enhance the offering from Kmart and Target.

-New verticals have recently been introduced by Catch
-Replaces potential future capital expenditure to improve online offer
-Opportunity to leverage the distribution centre network and fulfill marketplace products sold on Catch
 

By Eva Brocklehurst

Another month, another acquisition. Following its plays for Kidman Resources ((KDR)) and Lynas Corp ((LYC)), Wesfarmers ((WES)) will purchase online retailer Catch Group Holdings for $230m, one of Australia's largest online retailers.

In Citi's view, this adjacent acquisition presents better value for shareholders, as the prize is the expansion potential for the e-commerce offering of the company's Kmart and Target discount department stores. There are also likely to be synergy and scale benefits to the supply chain.

The acquisition will be funded by existing debt facilities and Catch should operate as an independent business unit under the Wesfarmers grouping. It will be overseen by the Kmart managing director, Ian Bailey. The acquisition price compares with FY18 revenue of $262m and operating earnings (EBITDA) of $6m. Credit Suisse notes gross transaction value was $250m for the six months to December 31, 2018, generated via in-stock retailing.

New verticals in mobile, personal loans, insurance and energy have also been recently introduced. The company operates two distribution centres in Melbourne, the most recent secured in October 2018. Citi expects these distribution centres will complement the existing supply chain, which is currently geared around store delivery.

The benefits, outlined by UBS, include the utilisation of these two highly-automated centres, the leverage for Kmart/Target sourcing and buying, as well as the opportunity to sell Kmart, Target or Bunnings products through the Catch online portal.

Credit Suisse agrees the acquisition provides important capabilities and, with an automated supply chain, strong online marketing and data, it is easy to envisage the opportunities for Kmart and Target. Moreover, if in the longer term the company decides to divest the discount department stores, the inclusion of Catch would create a more attractive proposition, the broker observes.

The acquisition, essentially, replaces future capital expenditure that would have been required to improve the "rudimentary" online offer from Kmart and Target, and Citi envisages benefits from scaling as the online channel grows and bricks-and-mortar like-for-like sales growth slows. While difficult to quantify, productivity benefits should also be available across the supply chain, fulfillment and online execution. Kmart's Anko brand could also be introduced into the Catch marketplace.

Risks

The main risk for Catch Group comes from local peers, such as Kogan.com ((KGN)) and Amazon/eBay for the marketplace business. Scale and funding are also issues for online retailers, although UBS believes Catch Group will avoid this pressure by adding existing retail products to the platform from the Wesfarmers stable, with the potential to invest further in price and service.

Credit Suisse assesses the investment is unlikely to generate an adequate return on financial metrics on a stand-alone basis in the near to medium term. Rather, the acquisition likely reflects a view by Wesfarmers that certain capabilities are required for success in the new retail environment. Positive indicators, in the broker's view, are the intention to maintain independence for the organisation and retain key management. A potential synergy is the Wesfarmers' Fly Buys program.

Limited Financials

No financial details were released. UBS estimates Catch should generate over $15m in earnings (EBIT) in FY20, although this is likely to be immaterial to earnings per share. From a cash flow perspective, the broker suspects there will still be further investment required in the new distribution centre.

Credit Suisse notes profit margins declined to 2% in FY18 from 5% in FY17 for Catch, amid pressure from higher personnel, sales & marketing expenses. Gross margin was steady at 35% of sales. The broker assesses cash flow was reasonably attractive up to FY18, the point where working capital expanded because of a reduction in trade payables. Inventory, as a percentage of the cost of goods, has been declining, which likely reflects improved supply chain efficiency.

Catch Group is primarily a "daily deal" retailer that sells branded goods through limited promotional offers. A marketplace was launched in 2018 and, while growth is strong, it is a small part of the revenue mix. Club Catch offers member-exclusive deals, club discounts and free standard shipping for eligible orders over $45 through a monthly or annual subscription.

Catch Energy offers electricity to customers in Victoria, NSW and south-east Queensland and gas to customers in Victoria through a partnership with 1stenergy. Catch also offers deals on pre-paid mobile plans by leveraging a partnership with Optus, and personal loans through a partnership with NOW Finance.

FNArena's database shows four Hold ratings and three Sell for Wesfarmers. The consensus target is $32.25, signalling -12.8% downside to the last share price. Targets range from $29.00 (Citi, Morgan Stanley) to $37.13 (Macquarie, yet to comment on the acquisition). The dividend yield on FY19 and FY20 forecasts is 7.5% and 4.2% respectively.

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