As company reporting season winds down, the standout theme has been the performance of consumer-facing companies. They have been big winners because thanks to the Government stimulus, the consumer is cashed up. With no overseas travel and ultra-low interest rates, sales of electronic goods, home furnishings, hardware, DIY, sporting equipment, recreational goods, cars and other items are booming.
A key player in serving the consumer is the Wesfarmers Group (WES), which owns Bunnings, Kmart, Target and Officeworks. While it is predominately a retailer, It is also Australia’s largest conglomerate, with interests in chemicals, fertiliser, industrial safety and lithium mining.
Wesfarmers has been a steady and consistent performer, up 7% in calendar 2021 and recently hitting a 52 week high. It closed on Friday at $54.01. Last week, it released its results for the December half year, which while beating broker analyst forecasts, didn’t lead to a jump in share price. So, can Wesfarmers go higher, possibly up to $60?
Wesfarmers (WES) – 12 months to February 21
A strong first half
Underlying net profit after tax rose by 25.5% to $1,414m, with the interim dividend up 17% to 85c per share. This was driven by the performance of the three retail divisions: Bunnings, Kmart and Officeworks.
Bunnings was the usual standout. On the back of store-on-store sales growth of 27.7%, it grew EBT (earnings before tax) by 35.8% to $1,274m. This represented 62% of the Group’s performance.
The Kmart Group also recorded strong sales growth, with Kmart comparable store sales up by 9.1% and Target up by 13.0%. The improved performance of Target helped the Kmart Group register a 42% improvement in EBT to $487m.
On sales growth of 23.6%, Officeworks grew EBT to $100m for the half year.
The chemicals, energy and fertilisers division saw EBT decline by 7.5% to $160m (just 8% of the Wesfarmers Group). Revenue was down across the board, impacted by lower volumes and lower realised prices. Industrial & Safety, which is chiefly the Blackwoods work safety business, witnessed improved earnings to $37m.
Looking ahead, Wesfarmers said that retail sales had remained strong in January and February and the outlook was more positive. While customers spending more time at home while Covid-19 restrictions remain is likely to support higher demand across the Group’s retail businesses, sales growth is expected to moderate from March as the businesses begin to cycle the initial impacts of Covid-19 in the prior year. There will also be additional costs of about $10m per quarter to provide a Covid-19 safe environment.
Cashed up and lithium upside
Wesfarmers is cashed up with net cash of $871m on hand as of 31 December. This is up from $471m on 30 June, and compares to net debt of $2,317m a year earlier.
One of the areas where cash will be deployed is the Mt Holland lithium project in Western Australia. Wesfarmers owns 50% of the project along with partner SCM of Chile and announced final approval of the project. The major asset of Kidman Resources that Wesfarmers acquired in 2019, the project will potentially be the biggest producer of lithium hydroxide in Australia. Wesfarmers’ share of capital expenditure is estimated at $950m, with first production scheduled for the second half of 2024.
Wesfarmers’ healthy cash position is due to its decision to exit a number of investments in 2018 and 2019, chiefly its thermal coal mines, and the strong cash generative nature of its retail business. Notwithstanding the capex that will be deployed into Mt Holland, Wesfarmers will still be in a very strong position. It has considerable capacity with its balance sheet to consider further acquisitions, or if can’t get then at the right price, a capital return to shareholders.
What do the brokers say?
On the whole, the brokers see Wesfarmers as fairly valued. In regard to target price, the consensus is $53.02, 1.8% lower than Friday’s close of $54.01. As the following table shows, the range is a low of $45 from Citi to a high of $59.30 from Macquarie. There is 1 buy recommendation, 4 neutral recommendations and 2 sell recommendations.
While the December half year result was a “beat” for most analysts, they are a little concerned about growth moderating from March. On a price earnings multiple, some analysts see Wesfarmers as fully priced with it trading on a multiple of 29.4 times forecast FY21 earnings and 27.0 times forecast FY22 earnings. The forecast yield is 3.1% (fully franked).
A capital return is considered unlikely in the short term, with most favouring further acquisitions.
What’s my view?
My sense is that Wesfarmers can go higher and potentially up to $60 because I don’t think the consumer is going to stop spending. 2021 will be another boom year for consumer facing businesses.
While there is always a question about how Bunnings can keep growing, year in, year out, it has demonstrated a remarkable record of growth. The woes of Target seemed to have been solved, Officeworks goes from strength to strength, and there is potentially upside with the chemicals, energy and fertiliser division.
The lithium investment should be a good long term play and is looking like an astute purchase. Similarly, Wesfarmers exit from coal mining appears to be well timed.
Wesfarmers has been very disciplined on the acquisition front (just Catch and Kidman resources since CEO Rob Scott took over), and that’s important for shareholder confidence. If they cannot find the assets at the right price, there is the potential bonus of a capital return.
Finally, apart from overall market pressures, downside risk is measured. Wesfarmers is perceived by the market to be a well-managed, reliable, ‘blue-chip’ company with market leading businesses. I think consensus earnings upgrades are more likely in 2021, and on that basis, the price will head higher.
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