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Morningstar | Further Clarity on Proposed Coles Demerger Doesn't Change AUD 37.50 FVE for Wesfarmers

Narrow-moat Wesfarmers announced further details of the proposed demerger of Coles, now anticipated to be completed in November 2018. Expected net debt levels of AUD 2.0 billion for Coles are lower than our previous estimate of AUD 2.7 billion, and Wesfarmers intends to retain a 15% stake post-demerger, lower than our previous estimate of 20%. However, the changes are of little consequence to our unchanged Wesfarmers fair value estimate of AUD 37.50, as the shares are naturally not yet trading ex-demerger entitlement.

At the time that Wesfarmer indicated its intention to retain a stake in Coles of up to 20% post-demerger, we expected its stake to be at the top end of this range. However, the firm has now announced it intends to retain a lesser 15% stake in the country's second-biggest supermarket chain. Wesfarmers expects Coles to institute a payout ratio of 80%-90% of earnings, markedly higher than the 70% we forecast for Woolworths, and in line with the 80% payout we forecast for Wesfarmers in its current form. We expect the relatively high payout ratio to appeal to income investors, but it also highlights the lack of organic growth opportunities in the mature Australian grocery market.

With four new appointments announced today, the Coles board is beginning to take shape. James Graham is chairman-elect of Coles, stepping down as a nonexecutive director of Wesfarmers. Three nonexecutive directors have also been nominated, including David Cheesewright, the Wesfarmers' nominee, who will be appointed as an advisor to the Wesfarmers board. Steven Cain, incoming managing director of Coles, brings the total up to five, leaving three more positions to be filled.