EUR 850.00 For Business Accounts Only

Morningstar | Wesfarmers Delights Shareholders with Special Dividend Detracting from Brewing Threats for Retail. See Updated Analyst Note from 21 Feb 2019

Wide-moat Wesfarmers declared an AUD 1.00 special dividend on top of a Coles-inflated AUD 1.00 interim dividend--both fully franked--with share prices up 7% on the news. The return of excess funds and franking credits is sensible, especially against the backdrop of potential changes to franking rules after the federal election in May 2019.

Looking past the special dividend, underlying sales growth at Wesfarmers’ largest profit contributor, Bunnings, is decelerating. The company flagged the weakness in its department stores segment in January 2019.

Growth in operating profit at the group’s largest segments was in line with our full-year estimates. The smaller industrials segment’s EBIT beat our forecast, and we increase the full-year contribution by AUD 50 million. However, the impact on our fair value estimate is immaterial and we maintain it at AUD 29.

Bunnings' like-for-like sales growth slowed to 4% in the first half of fiscal 2019, from about 6% in the previous six months, and 9% in the first half of fiscal 2018. We expect the days of high-single-digit comparable sales growth are over, as we expect it to be increasingly difficult for Bunnings to drive above-market sales growth by adding new products and expanding its range. Our like-for-like growth forecasts are unchanged at 4% for fiscal 2019, and average 3% longer term.

Cyclically soft consumer sentiment is a challenge for all retailers, including Bunnings. But were the weakness in housing prices to be prolonged and construction and renovating activity slow further, the impact could be more severe for hardware retailers. Highlighting slow demand growth in the bath and kitchen categories, ASX-listed GWA Group, a leading manufacturer and distributor of building and household fittings, estimates the Australian alteration and addition market grew at a tepid 1% in the past twelve months. Management expects the moderate trading conditions of the first half to continue for the remainder of fiscal 2019.

Bunnings accounts for 55% of group EBIT from continuing operations, and EBIT increased by 7.9% on the previous half, tracking our unchanged full-year forecast of 7.8% in fiscal 2019. A decline of 3.8% in operating profit at the second-largest business segment, Kmart Group, was also broadly in line with our unchanged estimate of a 3.5% decline in EBIT for the full year. The Kmart Group, consisting of discount department store chains Kmart and Target, is the number-two segment of the group and accounts for 22% of group EBIT from continuing operations.

The industrials division and stationery retailer Officeworks reported stronger than expected results. Further disruptions at Orica’s Burrup plant have delayed the looming oversupply of explosive-grade ammonium nitrate in Western Australia and we now expect Burrup to be fully operational from early fiscal 2021. The issues at Burrup resulted in stronger demand for Wesfarmers’ product than we had expected. However, we anticipate the oversupply to eventually impact the earnings outlook in the medium term and we forecast the industrials segment’s EBIT to rebase in fiscal 2021, declining by 8% that year.

Yet again, Officeworks was a highlight of the Wesfarmers results. We’ve increased estimated sales growth to 8.5% from 7.0% in fiscal 2019 and lifted long-term average EBIT margins by 20 basis points to 7.5%. However, it is the smallest segment, representing 6% of EBIT from continuing operations, and our upward adjustments to our estimates are immaterial to our intrinsic valuation of the group.

At its January 2019 trading update, Wesfarmers foreshadowed the possibility of capital management, in the absence of an acquisition, when it preleased its unaudited net debt position of a mere AUD 0.3 billion--peanuts for Australia’s largest conglomerate generating an EBITDA of AUD 4.1 billion in fiscal 2019 on our estimates. Adjusted for capitalised lease commitments, we estimate the net debt figure jumps up to AUD 7.1 billion, or AUD 8.2 billion including the special dividend. However, at an adjusted net debt/EBITDA of 1.4 the balance sheet remains conservatively geared.