Wesfarmers: High returns are just the beginning…

Over the past 20 years, Bunnings sales revenue and earnings have never gone backwards, despite multiple housing cycles, the Global Financial Crisis and competitor Masters entering (and exiting) the market.

Today, yet again, the business has not disappointed.  Despite a significant slowing in the Australian residential property market, Bunnings was able to post revenue growth of 5.2% and EBIT growth of 7.9% for the 6 months to December.  This result was delivered despite high rainfall across the east coast and a high comparable in the prior year.   In our view this is a solid result and illustrates just how resilient this business is. 

Bunnings continues to generate eye-watering returns on capital… up 2.8% this half to 50.2% and EBIT margins also increased 30bpts to 13.5%. With returns of that magnitude, Bunnings is arguably the best retailer that Australia has and in our view should be deserving of a premium multiple versus the broader market.  While the success didn’t translate across into the UK market, the Australian operations have gone from strength to strength despite several senior management changes, highlighting the depth of talent within the business. 

To date the slowdown in the property market appears to have had a negligible impact on the earnings. While it is certainly something to remain vigilant on, we expect the business to weather the cycle well which is contrary to the more extreme, negative views on property in the market.

Looking at the broader WES result beyond Bunnings. Overall the company delivered a solid result, complicated by the demerger of Coles and other asset sales (Bengalla, KTAS and Quadrant).  Adjusting for these items, EBIT grew 9.5% and Net Profit after Tax grew by 10.4%.  Divisional cash flow generation remains strong at 115% and, despite some moving parts, with the Coles demerger the cash realisation ratio was 98.5%.

A highlight of the result was the announcement of capital management via a special dividend of $1/share fully franked, in addition to the interim dividend of $1/ share fully franked. The balance sheet of WES is undoubtedly strong with just $324m of debt at 31 December. Management has taken this into account, along with the strong cashflow generation and availability of excess franking credits to take the opportunity to return capital to shareholders.  Even after this special dividend the balance sheet will be in a robust position with strong credit metrics.  We expect WES management is scouring the country for potential value accretive acquisitions.  We estimate the current balance sheet could accommodate an acquisition size of c.A$10bn and is likely to be a keen focus of the market over the next 12mths.

A cautionary outlook.  As is customary for WES, Management did not provide explicit earnings guidance, however the commentary did take somewhat of a cautionary tone, particularly around the consumer. Specifically, WES indicated:

“cost of living pressures and a decline in residential housing conditions have contributed to a moderation in retail spending growth and consumers remain cautious and value conscious”

This is reasonably consistent with some of the other consumer-facinging ASX listed companies that have already reported. Given the laser like focus on ‘customer value’ from Wesfarmers’ two biggest businesses, Bunnings and Kmart, in our view WES is better placed than most to withstand an economic downturn in Australia.

Bunnings contributed 57% of WES EBIT for 1H19.  We see the industry structure of hardware in Australia as very robust, with both WES and Metcash rational players, targeting slightly different customer segments.  Importantly we also see this industry as more immune than other discretionary retail to the threat of online disintermediation.  After all, it is hard to get timber, tins of paint, or a punnet of petunias through the post!

We continue to like WES as a business and consider the company a core portfolio holding.

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The above is general information only and does not consider any particular investor’s circumstances. It is based on the opinion of the author alone and is not intended to be a research report. The information should not be relied upon to make an investment decision without seeking further information and/or advice from a financial adviser and considering whether any investment is appropriate in the circumstances. Past performance is not a reliable indicator of future performance.

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