Good result, wrong price. Why Airlie is underweight Wesfarmers

• Revenue up 3.4% to $47,274m vs $47,246m ests (in line)
• EBIT (ex-items) up 7.3% to $4,493m vs $4,442m ests (1% beat), with reported EBIT up 0.6%
• NPAT (ex-items) up 8.3% to $2,874m vs $2,833m ests (1% beat)
• Operating cash flow down 6.5% to $4,272m on deliberate working capital investment in WesCEF spodumene and fertiliser inventory and Health contingency stock, with retail cash realisation at 99%
• Final fully franked dividend of 120cps takes the full-year payout to 222cps vs 219.2cps ests (1% beat), up 7.8%, on top of the $1.50 per share capital management distribution paid in December totalling $1,703m
• FY27 net capex guided to $1,300–1,500m including about $200m on the Mt Holland mine and concentrator expansion, with borrowing costs expected to be higher on increased net debt and cost of funds
• Mt Holland spodumene production guided to nameplate of roughly 380kt in FY27 (WesCEF share about 190kt) after FY26 production of 209kt beat both guidance and nameplate, though refinery ramp-up was hampered by intermittent odour issues
• On current trading through the first seven weeks of FY27, Bunnings sales growth was slightly stronger than 2H26 helped by dry July weather, Kmart Group was in line, and Officeworks stayed positive but slightly below. Blackwoods and Workwear Group moved into Bunnings from 1 July 2026.

Do you currently hold the stock and what is your rating?

We're currently very underweight Wesfarmers on valuation grounds with the stock trading on about 30 times FY27 EPS. 

We like the quality of the businesses they own and we rate management very highly, but 85% of the earnings come from Bunnings and Kmart. 

And we think you can get high quality retail exposure on the ASX at much better valuations. Think of names like JB Hi-Fi, for example, which is trading on 15 times earnings.

How do you explain Wesfarmers trading at a premium? What's your take on why the market seems so comfortable paying up for Wesfarmers?

I think it's obviously a very resilient business. They've got the WesCEF business which is a bit countercyclical and their retail businesses tend to perform in all market conditions as we saw in this result as well. So I think it's a good ballast to the portfolio - but we do think it's overvalued at 30 times.

What matters from the results?

Given 85% of the earnings come from Bunnings and Kmart, we think the profit numbers for those two businesses are really the key metrics to track. Those businesses grew profits five and six percent respectively which was just ahead of sales growth. 

That's pretty good operating performance in what was a challenging consumer environment in that second half in particular. 

A lot of investors also own this stock for the capital returns. So the final dividend of $1.20 per share was in line with expectations. It takes the full-year ordinary dividends to $2.22, which equates to a 2.7% yield.

Wesfarmers shares are down around 3% versus the broader market down 1% - so a modest negative reaction. What's likely driving the underperformance today?

I was expecting a flat reaction just given the inline result. But perhaps the outlook's been interpreted a bit softer than expected. 

If we step through that, I thought the trading update for Bunnings was positive. Sales growth in the first seven weeks is tracking ahead of the second half growth rate of 4%. But management did caution that it was an unseasonably dry July - so maybe don't extrapolate that for the full year. 

From our perspective, we're a little cautious as well in terms of the outlook for Bunnings just given the slowdown in housing turnover and lower house prices. We think that could impact both the DIY and the home builder segment in terms of demand. 

If we turn to Kmart, sales growth in the first seven weeks is tracking in line with the second half at about 2.8%. That's probably a touch lighter than what the market expects for FY27. 

You would expect a discount retailer in a challenging consumer environment to take a bit of market share as customers trade down and become more focused on value. So, I think people would like to see that accelerate as the year goes on. 

And the other segment we haven't talked about is WesCEF, which I think will be a key driver of earnings growth in FY27. This business will benefit from higher ammonia prices flowing through sales contracts. 

They've also increased production capacity in sodium cyanide and also the lithium business is well placed with spodumene prices pretty elevated at the moment as well.

What's your outlook for Wesfarmers over the medium term?

Despite the soft start to FY27, we think the real bright spot in the business is Kmart over the next 5 years. 

They're innovating very nicely. They've launched K Home which is a dedicated furniture offering and we think that could take meaningful share off the likes of IKEA, Temple and Webster and Fantastic Furniture at the lower end of the market. We think furniture is a pretty high margin category. So we think that can drive sales growth and earnings growth for the business.

They've also launched the Anko brand globally - they've opened some stores in the Philippines, so we think that an international path to growth is also an option for them as well.

If we look at Bunnings, their earnings growth has probably lagged Kmart over the last few years, but we think if management can drive a bit better sales density and bring them in line with international peers like Home Depot, you could see margins expand in that business and on a 20 billion sales base. Small margin improvements can have a meaningful impact on profits. That's potentially another good source of upside.

What could you be wrong about?

I think if you're trading on 30 times earnings, you've got to deliver mid to high single-digit earnings growth. I think Kmart can deliver that, but I do have concerns about that housing market impact on Bunnings, and also the sustainability of those elevated commodity prices in WesCEF. 

So to the extent Bunnings can outperform in that tough housing market, or the housing market is better than people expect, we could definitely be wrong on that sort of nearer term earnings trajectory for Bunnings. 

But nevertheless, we feel pretty comfortable owning other retailers at the moment that we think are high quality and trading at much better valuations, whether it's JB Hi-Fi or or Nick Scali.