Challenges Ahead For Wesfarmers

Australia | Jun 10 2022

This story features WESFARMERS LIMITED. For more info SHARE ANALYSIS: WES

Rising rates, a slowing economy and falling house prices are creating operational headwinds for Wesfarmers.

-Brokers mixed on strategy day initiatives and impact of OneDigital
-Slowing housing market, higher rates could weigh on Bunnings and retail divisions
-Higher commodity prices to buoy WesCEF

By Nicki Bourlioufas

Slowdown in housing market could hit Bunnings division

Wesfarmers’ ((WES)) strategy day has failed to changed some brokers’ minds about the difficulties the company faces in light of higher interest rates and a slowdown in the Australian housing market.

The combination of both could strike at the earnings the conglomerate derives from its Bunnings, K-Mart and Target stores.

At its strategy day, Wesfarmers announced it is digitising its stores and enhancing its online operations to reduce costs, convert revenue growth into profit growth and improve its ‘best value’ positioning.

Wesfarmers also announced capability improvements including supply chain optimisation.

Importantly, Wesfarmers is accelerating its OneDigital rollout and has announced that Catch will join the OneDigital division. Together with the OnePass subscription program and Wesfarmers Advanced Analytics Centre, all will sit under the OneDigital arm.

The company also announced an expansion of WesCEF (shortcut for Wesfarmers Chemicals, Energy & Fertilisers) through the Mt Holland lithium project, plus investment in the growth of its new Health division’s recent purchase of Australian Pharmaceutical Industries, which owns the Priceline brand.

Wesfarmers says its strong balance sheet will equip it for a more challenging macro-economic environment ahead, including higher interest rates and inflation.

Morgans is the most upbeat on Wesfarmers’ strategy initiatives. The broker likes the OneDigital plans.

Morgans believes OneDigital could become a powerful tool for Wesfarmers given the company’s broad sector exposures. Wesfarmers is considered a core long-term portfolio holding “with a strong mix of businesses, highly regarded management team and a healthy balance sheet”.

 Morgans rates the stock Add (equivalent of Buy).

Given Wesfarmers has strengthened its e-commerce capabilities and extended the benefits of OnePass membership program to Kmart and Target, Ord Minnett says the digital upgrade presents “a significant opportunity”.

OneDigital losses should begin to narrow from FY24 as revenues gradually build up. Ord Minnett has maintained its Hold recommendation, but reduced its target price to $51.80 from $52.40.

Other brokers are demonstrably less sanguine about the short-term challenges ahead.

Goldman Sachs suggests any success of OneDigital and OnePass, as well as API synergies remain yet to be proven.

With OneDigital and Health leadership only freshly appointed and Catch roles still to be filled. Goldman sees better value elsewhere.

The broker finds Wesfarmers’ risk profile in the present context is “elevated” and sees a driver of valuation compression.

Goldman did lift its price target for the shares, but only slightly so: to $40.00 from $39.40, while maintained its Sell rating.

Higher rates could hit retail businesses

A common view among analysts is that higher interest rates could curtail growth for Wesfarmers' retail businesses.

With the RBA raising interest rates by 50 basis points this month, and more rate rises to come, consumers are a significant source of uncertainty for retail spending, with higher inflation and mortgage repayments increasing pressure on household budgets.

Wesfarmers’ core engine Bunnings could be especially challenged by the housing slowdown, some brokers say.

Citi is especially sceptical of the market’s growth expectations for Bunnings, which it says are substantial at around 8% five-year compound annual growth rate (CAGR) for revenues through to FY24.

Bunnings sales are correlated to house prices, highlights Citi. The broker is predicting falling house prices are likely to result in low single digit like-for-like sales growth as opposed to high single digit sales growth when house price growth is strong.

Citi thus sees better value elsewhere in the retail sector and has maintained its Sell rating on Wesfarmers with a price target of $42.00.

Macquarie is equally sceptical. While it thinks Bunnings is one of the best retail assets in Australia, Macquarie shares the concerns around consumer discretionary.

Wesfarmers aims to expand or open 15 to 20 Bunnings stores a year and Macquarie notes the acquisitions of Beaumont Tiles and Tool Kit Depot could help lift commercial sales. 

Nevertheless, given higher interest rates, Macquarie has reduced its price target by -13% to $47.50.

The broker notes falling earnings multiples for Home Depot, Lowes, Target and JB Hi-Fi in Australia. Macquarie has maintained its Neutral rating.

Credit Suisse is also Neutral on Wesfarmers, even cynical about the company’s strategy day.

The broker feels challenged by the significant number of new initiatives, which Credit Suisse believes increases overall complexity.

The broker notes an absence of public measurable targets from Wesfarmers. Credit Suisse sees losses from OnePass and Catch “extending into an undefined future” and has lowered its price target to $49.68 from $55.19.

Ord Minnett is slightly more upbeat. It notes “powerful tailwinds” for Wesfarmers’ earnings from the chemicals, energy and fertilisers (CEF) division generated by higher gas and ammonia prices.

Ord Minnett also points out Bunnings, Kmart, Target and Officeworks are well placed versus smaller competitors given higher average selling prices and scale advantages.

FNArena’s consensus target price for Wesfarmers, based upon six major stockbrokers’ targets, currently sits at $50.90, suggesting 13.6% upside to the last closing share price.

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