Wesfarmers Outlook All About Turning Coles Around

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This story features WESFARMERS LIMITED, and other companies.
For more info SHARE ANALYSIS: WES
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

While it wasn’t originally part of its plan when launching the takeover for Coles last year, Wesfarmers ((WES)) has returned to the market to use equity to refinance some of the debt associated with the acquisition and announced a 1-for-8 rights issue at $29.00 per share to raise $2.5 billion.

Given the issue has been well flagged in recent days there are no changes to broker ratings now the issue details have been confirmed, but as Citi points out the issue removes refinancing as a risk factor for the group and will allow it to get on with the business of improving the performance of the Coles assets.

On the broker’s numbers the issue will actually be earnings per share neutral, while Credit Suisse sees a minor negative impact in FY09 given the increase in shares on issue. Offsetting this, the broker expects the issue will be positive for sentiment towards the stock as it improves the debt situation without having too great an effect on earnings.

This is the short-term impact though and the broker is a little less positive on the medium-term outlook as it points out the Coles food and liquor operations continue to lose market share to main rival Woolworths ((WOW)), this at a time when discretionary spending is feeling the pinch from recent hikes in interest rates. This puts pressure on any turnaround in performance at KMart and Target in particular as they are more exposed to the discretionary spending end of the market.

Merrill Lynch takes the view the equity raising is the correct strategy for the group to pursue, but the main issue remains the deteriorating performance from the Coles operations. The broker notes the food and liquor operations delivered third quarter comparative sales growth of 3.2% against inflation of 4.5%, meaning sales growth was actually negative in the period and was less than the increase in costs experienced.

With KMart and Officeworks also performing poorly off already low bases the broker sees little to get enthused about and so retains its Sell rating on the stock, as in its view the only way to fix Coles will be to open the chequebook and invest more capital in the business.

Such an approach is being complicated by the high price paid for the operations and the current limit on capital that can be raised, leading the broker to suggest it will become increasingly difficult for the company to make up the ground it continues to lose to Woolworths.

The broker’s negative view on the stock is shared by JP Morgan, though according to the FNArena database more brokers and equity researchers in the market rate the stock as a Buy, including Macquarie, GSJB Were and Deutsche Bank.

As Citi points out with its latest Buy rating the turnaround potential with Coles remains significant if management can get things right, with the broker expecting margin expansion in coming months as costs are taken out and the running of the business improves.

As ABN Amro notes, one other element in Wesfarmers’s favour is the coal side of its operations are booming and other divisions such as Bunnings are travelling well and contributing more to group earnings, allowing profits to be maintained while the Coles restructuring takes place.

This is only enough to generate a Hold rating though in line with the view of Credit Suisse. Overall the FNArena database shows five Buy ratings,  three Holds and the two Sells mentioned, with an average price target of $42.05, down from $42.25 prior to the announcement of the issue.

Shares in Wesfarmers remain suspended as it completes the equity raising but the stock should recommence trading on the Australian Stock Exchange next week.

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