The turnaround at Coles has continued to deliver better supermarkets for its customers and improved returns for shareholders on the capital invested. But it has been a long and arduous journey to resurrect the one real competitor to the benchmark operator, Woolworths.
It may seem odd, but investors in Wesfarmers have been on the right bus as the improvements at Coles have translated into a rising share price for Wesfarmers. Conversely, the supremely well-run and logistically superior Woolworths supermarkets have given customers a better shopping experience but that is well factored into the share price at Woolworths.
[1]The poster child
The $16.1 billion of capital invested in Coles represents 53% of group capital invested, making it the single most important division with Wesfarmers. The rolling 12-month return on capital at Coles has steadily improved, to its best level of 9.5%, since Wesfarmers acquired it in 2007, yet it pales in comparison to other divisions with the company.
Bunnings and Kmart are the standout divisions with a return on capital – Wesfarmers’ favourite measure of performance – at almost 26% in each case.
At what point then will Wesfarmers declare it has reached a satisfactory return on its investment in Coles?
It is not a straightforward question to answer as the appropriate return for a supermarket is not necessarily the same as a discount department store or a chemicals and fertiliser business.
But this is the package investors get by owning a conglomerate like Wesfarmers.
The only real answer as far as shareholders are really concerned, is what lands in the bank account after a results announcement. In this case, the FY13 announcement included a final dividend of 103 cents per share (cps) fully franked (payment date, 27 September) taking the full year dividend to 180cps or 9.1% higher than last year.
Shareholder bonus
But Wesfarmers went a step further by announcing a capital return of 50cps, amounting to an extra $579 million to be returned to shareholders, subject to a final ruling on the taxation treatment from the ATO and shareholder approval at the AGM in November.
Wesfarmers chief financial officer Terry Bowen said: “The capital return is being made to return surplus capital to shareholders and to ensure that Wesfarmers maintains an efficient capital structure.”
The number of shares on issue will be consolidated by a factor of 0.9876, to provide an equivalent outcome to a share buyback of the same magnitude. The capital return represents 1.2% of Wesfarmers market capitalisation.
The black sheep
The problem child of the year was clearly Target. A new managing director has begun the task of clearing excess inventory and finding a formula that will generate acceptable returns on investment. This won’t be an easy task as Target has certainly lost its way, amidst an overcrowded apparel market and even more competition on the way.
Target’s EBIT margin has slumped from 10% in FY10 to 3.7% in FY13 indicating the scale of the problem for new boss Stuart Machin.
The gifted child
[2]
On the other hand, there seems to be no stopping Bunnings as the powerhouse home improvement big box in the $37 billion Australian market. Bunnings opened another 23 stores in FY13, taking the total to 210 warehouses, 67 smaller format stores and 36 trade centres.
If consumers were holding back on spending in the 2013 financial year, they certainly weren’t including spending at Bunnings in that decision. Total sales chugged ahead by 7% to $7.66 billion, helping EBIT to $904 million or about 24% of group EBIT.
Operating cash flow for the year improved to $3.9 billion, providing room for $2.3 billion of capital expenditure, mostly focused on the Coles and Bunnings property portfolios. Net debt of $5.2 billion was higher than last year, but the effective cost of borrowing has come down by a chunky 118 basis points to 6.65%.
We continue to prefer owning Wesfarmers over Woolworths for the on-going improvement at Coles and the superb performance in Bunnings. The rest of the group seems to be hanging on for the ride.
It is also encouraging to see the company walking the walk with regard to shareholders returns, so in that sense, continued ownership of Wesfarmers in a portfolio is worthwhile.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Peter Switzer: Are we tapering over the cracks? [3]
- Paul Rickard: Leighton Holdings – a yield play? [4]
- James Dunn: Smack down – more earnings pain [5]
- Rudi Filapek-Vandyck: Buy, Sell, Hold – what the brokers say [6]
- Penny Pryor: FoFA shake-up – Joe Hockey [7]
- Geoff Wilson: McMillan Shakespeare on the comeback [8]
- Penny Pryor: All steam ahead for property [9]