Australia | Jun 10 2020
This story features WESFARMERS LIMITED, and other companies. For more info SHARE ANALYSIS: WES
Sales activity at Bunnings and Officeworks has been stunning over the period of pandemic-related restrictions but signals there is very little operating leverage for Wesfarmers going forward.
-As restrictions lift, sales growth should taper
-Moderation in house prices, housing likely to impact sentiment
-Expansion of Bunnings online likely to be critical
By Eva Brocklehurst
Conditions during the coronavirus shutdown have actually favoured major Wesfarmers ((WES)) businesses, with both Bunnings and Officeworks recording substantial sales growth in the second half to date.
Credit Suisse was surprised at the strength of the update, although the resilience of home improvement-related sales (Bunnings) and working from home (Officeworks) was always apparent. Bunnings is likely to have outperformed the broader hardware segment over the period given, as the analyst plaintively describes, the “unending list of house maintenance requirements".
Still, the sales are treated as catching up rather than a pulling forward, amidst the support from household mobility restrictions and more free time. As these restrictions lift sales growth should taper.
Sales growth at Bunnings was 19.2% and Officeworks 27.8% over the year to date. Kmart and Target also experienced improved momentum, up 4.1% and down -1.8% respectively.
Channel checks have also indicated to UBS an acceleration in trade after April 25 but the big concern is whether there is a "fiscal cliff" developing once government stimulus ends. UBS upgrades revenue estimates across all divisions for FY20 and expects strong growth in the first quarter of FY21 as well. By the fourth quarter of 2020 comparable sales are likely to be negative.
All up, UBS considers Wesfarmers a strong business with a disciplined approach to capital and returns. Still, the businesses are cyclical and reliant on consumer sentiment and expenditure.
Headwinds will grow in FY21 as government stimulus measures end. Moreover, Bunnings is exposed to a moderation in housing and there is a weak backdrop in this regard over the next 12 months.
UBS forecasts a -5-10% decline in house prices which bodes negatively for the hardware chain once stimulus ends. Credit Suisse agrees 2021 house prices are likely to re-assert their dominance as a key correlation with sales growth.
Surplus funds also mean that acquisitions are a probability and this may provoke a negative market reaction initially, the broker adds. There is a need for Wesfarmers to streamline its business but Credit Suisse believes the risks of acquisitions/investment are likely to weigh on the share price performance.
Underperformance of the portfolio has occurred in line with the sell-down of the interest in Coles ((COL)) and growing funding capacity. Moreover, Bunnings accounts for around 70% of the comparison portfolio value, ahead of its 65% contribution to group earnings.
Citi also considers Wesfarmers lacks operating leverage. As restrictions ease and activity returns to normal, sales growth in FY21 is expected to go back to pre-pandemic levels.
Sales growth has come at a cost. Citi points out the incremental margin on the latest sales is 14.5%, lower than what would normally be expected with such strong growth. The broker expects this situation will continue in the second half.
Costs were higher at Bunnings, as around $20m was invested in cleaning, security and protective equipment over the past three months. Around $70m in costs will be incurred in FY20 because of the trading restrictions in New Zealand, store closures and the accelerated roll-out of the online platform.
Costs at Officeworks are also expected to remain elevated in the second half. Similarly, the temporary closure of NZ stores will affect Kmart earnings in FY20. Momentum has improved at Kmart and Target as foot traffic increased in shopping centres and there was a recovery in demand for winter clothing. Yet Ord Minnett anticipates supply chain issues at Kmart, and the conversion of some Target stores, will require more investment.
As a result of higher costs, Morgans remains cautious about how much of the improved sales will flow through to earnings. The broker may become more positive about the stock on any weakness in the share price.
Online sales growth of 89% in 2020 to date is very positive, given the slower trajectory of online sales penetration the company has experienced in the past. It appears to Macquarie that Wesfarmers is reaching new customers rather than cannibalising sales yet Citi disagrees, suspecting online demand at Bunnings is an incremental headwind to margins and largely cannibalising in-store sales.
The broker expects online sales for Wesfarmers will reach $1.5bn in FY20, excluding Catch, a 5.7% penetration rate. The online offer from Wesfarmers has lagged other category-leading retailers for some years, with the notable exception of Officeworks.
The company's three retail businesses are at very different stages of online development. Officeworks remains the strongest, particularly as it also manages a large shop-front channel. In contrast Kmart and Target have lagged department store peers Myer ((MYR)) and David Jones.
The recent expansion of Bunnings online will be critical, in Citi's view. This has started with click and collect and more recently the rolling out of delivery options.
FNArena's database has one Buy (Macquarie), four Hold and two Sell. The consensus target is $38.96, signalling -8.6% downside to the last share price. Targets range from $36.50 (Morgan Stanley) to $44.50 (Macquarie).
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