EUR 850.00 For Business Accounts Only

Morningstar | No Christmas Miracles for Wesfarmers' Discount Department Stores. FVE Unchanged at AUD 29

We make no changes to our AUD 29 fair value estimate for wide-moat-rated Wesfarmers following a trading update to December 2018. Since Wesfarmers' annual general meeting in November 2018, sales growth in department stores moderated further over the key Christmas period, slightly worse than we had expected. In our view, the division has reached its peak store footprint. We expect unprofitable stores will have to gradually close as online sales represent an increasingly larger slice of incremental sales. Outside department stores no quantitative detail was provided on the conglomerate's other divisions, which we will expect with the release of fiscal 2019 half-year results on Feb. 21, 2019.

Next to Wesfarmers' core hardware retailer Bunnings, discount department store Kmart's performance has been a standout of the retail portfolio. However, this sales growth weakened in the first half of fiscal 2019. Comparable sales in Kmart declined 0.6% over the six months to Dec. 31, 2018, more than offsetting positive 0.5% growth at Target. On aggregate, this was below our already cautious full-year like-for-like sales growth estimates of a 1.7% increase and a 0.4% decline for Kmart and Target, respectively, given Kmart's revenue is over twice Target's.

We've lowered our fiscal 2019 like-for-like performance to a 0.5% decline for Kmart, mitigated by a more-positive outlook for Target. As a result, excluding a 5% negative impact from the divestiture of Kmart Tyre and Auto Service, we estimate department store headline sales to increase by about 1% in fiscal 2019--down from 2% previously. Wesfarmers expects to post first-half EBIT for the department store segment of between AUD 385 million and AUD 400 million--a mid-single-digit decline from AUD 415 million in the previous corresponding period. This tracks our updated fiscal 2019 forecast of AUD 637 million, 3.5% lower than fiscal 2018 and virtually unchanged from our previous estimate of AUD 645 million.

Longer term, we forecast department store earnings to continue to decline at a mid-single-digit CAGR over the five years to fiscal 2023. We expect online competition and shifting consumer preferences to shrink retail spending in department stores, leaving Kmart and Target to compete in a dwindling market. For more detail, please see our special report published in December 2017 titled "Australian Department Stores Are Going Out of Fashion."

Wesfarmers noted net debt fell from AUD 3.6 billion at June 30, 2018 to an unaudited position of just AUD 0.3 billion at Dec. 31, 2018. As outlined in our May 2018 special report, "Wesfarmers Gearing Ready to Pounce," the divestiture of Coles provides Wesfarmers with an undergeared balance sheet. This boosts the firm's war chest, increasing the scope for a sizable transaction--or returning excess cash to shareholders. However, acquisition risk is always inherent in an investment in Wesfarmers, demonstrated by the recent acquisition challenges of U.K.'s Homebase.