Wesfarmers/WES

Wesfarmers, the big conglomerate, was out yesterday. A good result, overall.

Most divisions up, across the board, Kmart doing well, even Officeworks, Bunnings of course remains a jewel in the crown.

Same-store-sales growth for Kmark looked especially strong, in contrast to the more challenged Target. Kmark also made the Woolworths’ owned Big W result look especially weak. Bunnings has moderated from levels that were previously difficult to maintain.

That said, total revenue growth, total NPAT growth, was not especially strong. Rather, what is drawing investor support is the very high ROE that WES generates (over 30%) and very strong cashflows (126% cash realisation rate, up from 86%, an already “quite good” number). ND/EBITDA at 1.8x is also well regarded.

Margins in nearly all divisions either increased or stayed largely at trend. This is, in our view, a fairly solid outcome given inflationary pressures, and companies like Woolworths pointing to difficult cost environment (labour, rent, electricity) and general competition (in non food items, for Woolworths, strong competition from stores like Priceline, Chemist warehouse, are impacting sales of in-store items like hair product, dishwashing tablets, soap, you name it).

The “more discerning” customers continues to suggest to us that, overall, the consumer is indeed challenged. We’ve struggled to work out how to play this theme within the retail sector (e.g. do you buy WES to get Kmart, hoping it outperforms Myer or JB-Hi Fi or Premier’s suite of retail brands) or do you just avoid the sector. We avoided the sector, which didn’t turn out quite right (at least, not yet!).

This exchange regarding the Kmart margin uplift was particularly interesting. Permanant, all else equal..!

Bunnings is an excellent business, and we have exposure to home hardware and trade via Metcash, which has similar business lines, even if they cannot quite claim to be as magnificent as the mighty Bunnings.

Overall, the company is of excellent quality, I suppose, is the short summary, and people are willing to pay up to own quality. WES’s forward multiple isn’t even that high, at 23x; it’s not cheap, but it’s not crazy, and you can see why people are happy to hold it as a “core” exposure.

Minor other comments: they aren’t making any money on lithium, at the moment. Ramping up production at a time of depressed prices makes for a loss making endeavor.

And something else to keep in the back of the mind, as WES attempt to grow the Health segment (Priceline pharmacies, Silk laser clinics etc); it is possible WES simply fail to succeed; the business models are different to what they are used to, being a gun retailer in one category (perhaps unintuitively) does not simply extend to all others (just think of Fosters with beer, and then Fosters with wine, or even same business (Bunnings) new geography (UK) and how disastrous that was).

That line of thought is what Shaun is getting at in the below. Lithium, Health, these could wind up being cash and ROIC drags, even as they are held out as new growth engines.

Brokers liked it. Stock has traded well.

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