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Woolworths and Wesfarmers; they both command $44 billion market caps, have both outperformed the market over 12 months, and have both made significant acquisitions and divestments. The reality today is that these are two vastly different businesses. So, the question is, which is the better investment?

We look squarely at this decision in this week’s thematic discussion, with Ben Clark from TMS Capital hosting Vince Pezzullo from Perpetual and Adam Alexander from Evans & Partners. We ask what their key differences are, what this means from a valuation perspective and ultimately which is the pick of the two. Because as Ben quips here: ‘The prices may not be down, down, but these stocks are well worth having a look at’.

Transcript

Ben:
Welcome to Buy, Hold, Sell, I'm Ben Clark and joining me today I've got Vince Pezzullo from Perpetual and Adam Alexander from Evans and Partners. We're going to start off doing a deep dive into Woolworths and Wesfarmers. Two $40 billion market cap giants, but looking to the take, pretty different paths going forward from here. We'll start with a bit of an overview of the businesses. Vince, what do you see as the key differences between the two companies now and how do you factor that in when you're trying to value what you think these companies are worth?

Vince:
Well actually both of them were quasi-conglomerates really. Woolworths obviously had a lot more weight to supermarkets, but look what it's done in the last three years, which the management should be commended for. It's actually shrunk back towards being a supermarket business again, which is its core franchise.

Ben:
Okay, and Adam, have you got anything to add to that because Wesfarmers seems to be taking quite a different path. What are your thoughts there?

Adam:
Yeah, I think you've got to look at Wesfarmers as a manager of capital and Rob Scott's done a really good job over the past few years in selling businesses, sold Resources, sold Coles and getting back to the core franchise. When you look at the two now, probably compare Bunnings to Woolworths and when we assessed the businesses at sort of looking at the fortunes of what could happen to Woolworths versus Bunnings I think going forward.

Ben:
Yeah, because both these companies are taking some big divestments and big acquisitions in recent times. Do you think there's one that stands out in terms of strategy going forward that you prefer or you got a house view that you like?

Adam:
Yeah, I think probably Wesfarmers has a little bit more optionality. When you look at their biggest business, it's Bunnings. They're starting to move into the trade sector. They're also moving online. Then if you take a look at the Wesfarmers group as a whole, they've got some balance sheet power now. Optionality to go out and buy some new assets. They've deployed about a billion dollars into Catch and Kidman resources and they've still got plenty to go there.

Ben:
Yeah, and looking to deploy more Vince. The Lynas bid is still on the table but it's looking less and less likely. It seems an interesting move for Wesfarmers to be branching out on different-

Vince:
I have a slightly different view than Adam on this. I'm a bit, it was a bit more of a stalwart type stock, Wesfarmers, and if you think about where Woollies is going Woollies is going back to the core. They've liberated the balance sheet. A lot of excess capital now for their spin off of endeavour drinks. I think another capital return come from there, but they're going back to where their highest returning businesses, which is known in a pretty good industry structure as well. With Wesfarmers it's commendable they got rid of Coles, et cetera, and then moving to new areas. There is that risk about deploying a balance sheet into new industries where they don't have a history of it yet. I think if you think about a risk-return relationship given the multiples are quite similar, I think Woolworths has got a lower risk for the sort of return you can get. That's how we sort of think about it going forward.

Ben:
Okay. Have you had a thought about Endeavour yet? There's a demerger coming. Demergers have typically been pretty good places to be. Maybe not for the first six months or so, but you started to think about whether you'd like to be in that business or the ESG sort of things an issue?

Vince:
Well, fortunately, we run a couple of funds so that we do have an ESG type fund which can't obviously participate in the Endeavour drinks component. Actually fortunately Woolworths connection now be probably invested in for the ESG fund once that happens. We actually quite liked Dan Murphy's in the pub group itself. Pretty good businesses. They grow reasonably well. Whether Endeavour drinks can grow much faster than what it is doing today, I doubt it. Maybe on the hotel side you could probably grow it a bit quicker. We actually quite like the spin out of Endeavour drinks.

Ben:
Okay. Adam, Endeavour, have you had a thought about it and go on to the next question I had. Following on from that is, you used to really just look at consumer sentiment and those sort of things. When you're sort of thinking where these businesses are going, but now is there something you'd sort of call out that you think has a big impact on these companies? Like one single factor?

Adam:
I think it still is there, the health of the consumer. Definitely. When you're looking at Woollies versus Wesfarmers and Bunnings. I think Woolworths is more defensive, if things get really bad. We all still have to eat. We don't have to paint our house. I think in a downturn Woolworths will probably hold up a little bit better. For the long term, I think Endeavour, it gives shareholders the option of investing in the gaming and alcohol business versus the supermarket businesses. I think that's a great way to go. Giving investors the choice and by demerging-

Ben:
Let them choose what they want to do and Vince, a single factor? Is it still consumer sentiment? Is that the one for you or is there something else that you sort of think about there?

Vince:
I think you've going to also bring into that just any structural issues that everyone's talking about Amazon coming into supermarket retailing or retailing in general. I think you get, that consumer sentiment will go with GDP a little bit more, et cetera, moving around with that. If the industry structure's not right, that far outweighs any consumer sentiment issue. I think actually in retailing, I think it's gotten a bit better now that Coles have been spun out. Because it hasn't got a big group behind it, it has to sort of support its own returns.

Ben:
Okay. All right, so if you had to pick one, let's see what you think going forward, which is the one you prefer and maybe if you could just give us a couple of quick reasons why.

Vince:
It is, at this stage, particular around the lateness of the stock, it is Woolworths for that reason. They've basically done everything they said they would do three years ago, reinvested back in the core. It's a high returning business, supermarkets for them and divesting in the petrol business has been divested. They're getting rid of Endeavour drinks, et cetera. We're getting a lot of capital back and on all indications from management is they're going to reinvest back into the business, whether it's online, on retailing etc to defend the goal. I think, as Adam mentioned, it's a bit lower risk and I think at this point in the cycle it probably stacks up a little bit better for us.

Ben:
Okay. Adam? Woolworths, Wesfarmers, which is your pick. 

Adam:
Yeah, I'm going to have to disagree here and go with Wesfarmers, I think the core of that business is Bunnings. They are moving into the trade where they haven't really participated and tried to grow in the past. They've got the online piece, they're just starting to roll out. That'll give them some extra growth. Then the corporate level, the strong balance sheet and the ability of that management team to invest that capital, they have done well in the past. We think that can provide some sort of long term value creation. Third point it is slightly cheaper. Maybe one or two PE Points under and a 4% yield versus Woollies on about three. We'll go with Wesfarmers.

Ben:
Okay, well the prices aren't down, down, but these stocks are still well worth having a look at.

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