Wesfarmers On Drugs?

Australia | Jul 13 2021

This story features WESFARMERS LIMITED, and other companies. For more info SHARE ANALYSIS: WES

Wesfarmers has flagged its planned expansion into the personal care, health and well-being sector with a surprise bid for Australian Pharmaceutical Industries

-A strategic acquisition to expand opportunities post the pandemic
-Yet Australian Pharmaceutical has downgraded FY21 guidance
-Will the Wesfarmers bid be a catalyst for the personal care, health sector?

 

By Eva Brocklehurst

Not content being a hardware, discount department store and office retail conglomerate, Wesfarmers ((WES)) is planning to expand its territory into the personal care, health and well-being sector, seeking growth opportunities post the pandemic.

The company has submitted a non-binding indicative offer to acquire Australian Pharmaceutical Industries ((API)) for $1.38/share, a 21% premium to the prior close. Major shareholder Washington H Soul Pattinson ((SOL)), which has a 19.3% interest, has already indicated it will vote for the proposal, granting a call option in favour of Wesfarmers.

In the view of several brokers, this is a strategic acquisition, more about successfully executing a transaction rather than the specific quality aspects of the business being acquired. There is heightened competition in retail pharmacy from Chemist Warehouse as well as other online health & beauty platforms and more investment is required to turn API around.

Morgans believes the personal care sector can provide long-term growth opportunities although asserts Wesfarmers will need to invest in supply chain, systems and product range to improve competitiveness and operating efficiency.

This may be possible, given the strong retail and supply chain capability of Wesfarmers, but could take some years. Morgans accepts Wesfarmers' rationale because of the defensive growth qualities but points out industry margins are low and API has been negatively affected by store closures over the past 15 months.

Downgraded Guidance

In tandem with the bid, API has downgraded FY21 guidance and now expects underlying earnings (EBIT) to be $66-68m, as opposed to the previous guidance of $75m. This is largely because of the pandemic and the impact of the current restrictions in Sydney. If restrictions are not lifted as of July 31, this is expected to impact on earnings by -$1m per week.

API will also exit manufacturing in New Zealand by the second half of FY23 to focus on pharmacy distribution and its retailing businesses, Priceline and Clear Skincare.

Goldman Sachs has no view on whether the proposal will be completed but in the event it is successful believes API offers Wesfarmers exposure to another staple retail business. This would be a relatively small addition, with the broker calculating API would represent just 1.9% of Wesfarmers' FY21 earnings based on the mid point of the latest guidance.

CLSA considers the bid "uncertain" while suspecting it will be supported by shareholders because API is focused on the consumer rather than the industrial segment.

The transaction is unlikely to have a material influence on the valuation of Wesfarmers and the company does not appear to be paying a significant premium, in Credit Suisse's view. Still there are questions the broker poses for Wesfarmers, not to mention an unsuccessful foray with Homebase and struggle to right-size Target. Is this really the right vehicle to expand?

Citi had expected Wesfarmers to deploy its excess capital via acquisitions in the absence of tax effective ways to return capital yet envisages few synergies from this acquisition, estimating the transaction will be 1.7% accretive to earnings per share.

Higher Bid/Counter Bid

Credit Suisse suspects Wesfarmers may need to raise its offer in order to be accepted by API, as it is currently in line with where the shares traded in April 2021. Counter bids? The broker also points out speculation has always existed around an API/Sigma Healthcare ((SIG)) merger, given the recent underperformance in the latter's share price.

Yet, Credit Suisse does not anticipate Sigma will emerge with a counter bid for API, given it is a higher quality business and unlikely to pay a premium.

Sigma is also well into its turnaround strategy, has excess capacity in distribution centres and a strong balance sheet. Nevertheless, Credit Suisse considers the Wesfarmers bid can be a catalyst for Sigma to re-rate.

Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, has a Buy rating for Wesfarmers with a $59.70 target. The database has one Buy (Macquarie), five Hold and one Sell (Citi) rating for Wesfarmers. The consensus target is $53.45, signalling -8.7% downside to the last share price.

For API there are three Hold ratings and the consensus target is $1.33, suggesting -3.2% downside to the last share price.

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