Australia | Jun 07 2021
This story features WESFARMERS LIMITED, and other companies. For more info SHARE ANALYSIS: WES
After briefing on its multitude of businesses, Wesfarmers' priorities can be summed in terms of enhanced digital investment and product expansion, both vertically and through adjacent categories
-Incremental investment targeting digital aspects of the business
-Further expansion of hardware a priority through commercial trade
-Wesfarmers evaluating ammonia, ammonium nitrate expansion
By Eva Brocklehurst
When you think of Wesfarmers ((WES)) you think of strolling into Bunnings on a Saturday to shop. Right? Or Kmart and Target. Yet there is more to the conglomerate than retailing, albeit the other categories contribute a relatively small amount to group earnings. It doesn't stop there, with plans to continue growing the company's reach both vertically and via adjacent categories.
At its strategy briefing, the first in two years, Wesfarmers covered them all, highlighting it will make an incremental investment of around $100m over the medium term, spanning several initiatives that are primarily around building out the digital aspects of the business.
Wesfarmers will review its supply chain & distribution centres and investment in data/analytics while also expanding several categories within the hardware segment. Beyond FY21, Jarden envisages a material opportunity for Wesfarmers to expand the group's addressable market, although cautions significant investment will be required.
The broker believes Wesfarmers is one of the best positioned local retailers because of its scale, brands and more than $5bn in balance-sheet capacity, noting there are more than 400 people in its Advanced Analytics Centre while the Flybuys loyalty program, a 50-50 joint venture with Coles ((COL)), has also materially increased staffing over the past 18 months.
The company has narrowed the range of its net capital expenditure guidance to $650-700m from $650-800m and this includes the conversion of Target stores and the development of Mount Holland lithium.
Wesfarmers is also accelerating its digital capability through leveraging its investment in Catch, the online shopping experience, expanding the product range and providing flexible shopping and fulfillment options.
Catch will have another fulfillment centre in NSW in FY22, complementing the existing one in Melbourne. Around 45% of orders for Catch come from the mobile app and, relative to competitors, Macquarie notes brand awareness is low, so Wesfarmers is intent on investing in infrastructure and long-term growth initiatives.
In the short term Jarden, not one of the seven monitored daily on the FNArena database, believes the catalyst for Wesfarmers will be capital management and retains an Overweight rating and $59.00 target.
Yet Goldman Sachs, also not one of the seven, suspects digital investment and automating the supply chain will take up an increased amount of management's time and capital over the medium term. The broker acknowledges management is looking to size the balance sheet appropriately in a tax effective way and has not yet made a decision about how this will occur.
Acquisition opportunities are still being evaluated although the availability of capital has not meant this has increased as a priority, the broker observes. Goldman Sachs has a Buy rating and $59.70 target.
Citi points out Wesfarmers separates its capital management decisions from the funding of M&A, noting the company's intention is to return capital tax effectively where possible. The broker assesses Wesfarmers is being disciplined regarding transformative M&A in an environment of elevated asset prices.
Credit Suisse agrees that large-scale acquisitions are unlikely with the company homing in on adjacencies to those businesses where it is an incumbent and has scale advantages.
The database has one Buy rating (Macquarie), five Hold and one Sell (Citi). The consensus target is $53.45, signalling -3.2% downside to the last share price.
Macquarie notes Bunnings has experienced phenomenal growth for the past 25 years but remains open to further expansion through commercial trade. Growth has moderated, Wesfarmers highlighted in the briefing, as store traffic has returned and Bunnings is experiencing volatility in monthly sales.
Jarden assesses the medium-term outlook is positive but the news flow over the short term could be negative as the business cycles the spikes caused by the outbreak of covid-19. Bunnings is absorbing some price increases which the broker suspects will limit the level of positive operating leverage in the second half. Working capital is expected to be higher as stock levels are rebuilt.
Bunnings, at 62% of EBIT, will strengthen its presence in those categories where it deems there is wider potential, including electrical and plumbing. The company's specialist tool & power equipment retailer Adelaide Tools is believed to be in a better position than the current Bunnings outlets for targeting work being done by apprentices in the construction industry.
As a result Wesfarmers is scaling up Adelaide Tools and will expand outside of South Australia. The first store will open in Western Australia in the first half of 2022 and the store network target is 75 over the next 3-5 years.
Wesfarmers plans to link its membership program for commercial trade customers, PowerPass, to all trade brands and formats and in time believes this will become the accepted payment method at Adelaide Tools.
In April Wesfarmers also acquired Beaumont Tiles, providing more specialist categories that are harder to penetrate through the Bunnings format. Bunnings has a low penetration rate in the flooring category, too, and this represents an opportunity in Macquarie's view to grow both trade and retail.
Wesfarmers has reiterated its target for Kmart, intending to grow sales to around $10bn and earnings to $1bn. Kmart will incur pre-tax costs of $60-70m in FY21 related to Target store closures and conversions, which Macquarie flags is an improvement on the prior estimate.
Target is now a smaller business with 142 stores and the lease liability has reduced to $800m. Morgans is encouraged with initial trading from the conversion of 81 Target stores to Kmart and K Hub stores, given this is ahead of management's expectations. There are now two Target distribution centres as opposed to three and Wesfarmers intends to maintain the large format Target store network.
Officeworks has a 10% market share, although Macquarie points out incorporating extended technology, education and business the potential market doubles, to around $56bn.
The company intends to meet the demands of schools and tertiary institutions in the education and art categories and envisages an opportunity in a hybrid office/home work model. Furniture is also experiencing growth with chair sales set to reach 1m in 2021.
Wesfarmers has made a significant investment in the Mount Holland lithium project involving capital expenditure of around $950m and construction is due to commence in the second half of 2021 with first production in the second half of 2024.
Meanwhile, there has been strong demand for explosives-grade ammonium nitrate from Western Australian customers, resulting in lower exports and fertiliser sales, and Wesfarmers is evaluating ideas around expanding its production capacity across ammonium nitrate, ammonia and cyanide.
Credit Suisse highlights this is a departure from the previous policy of avoiding expansion of the commodity footprint and believes ammonia would require investment of $180m. Based on long-term forecasts for ammonia Wesfarmers would also need gas at $6/gigajoule to make the economics sufficiently attractive.
In the case of ammonia, the idea is to vertically integrate, Macquarie suggests, and the company will lodge a major project plan over the next month, looking to close a shortfall at Kwinana. The chemicals business is being affected by rising ammonia pricing, Macquarie points out, noting Orica ((ORI)) has experienced similar pressure.
In terms of ammonium nitrate expansion, the broker suggests this is more likely to be a de-bottlenecking rather than a major expansion and occur later in the timetable. A solid demand environment is keeping ammonium nitrate prices strong while fertilisers are expected to benefit from a robust harvest.
An area which has disappointed Macquarie over recent years is the industrial segment although Initiatives to turn around Blackwoods that involve building market share are showing some signs of improvement.
Meanwhile, Coregas expanded its presence in health care through supplying oxygen to hospital groups during the pandemic. There has been around 10% growth in workwear where the company has leading brands and Greencap, the risk management service provider, is consistently growing online sales at around 20% per annum.
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