The annual Wesfarmers Strategy Day presented a resilient company able to withstand a softening consumer spending environment. Significant work remains to be done in eCommerce across the group, but it has a strong presence in each of its markets to leverage. The conglomerate structure continues to offer investors an array of mature and developing businesses.
The curious thing about Bunnings is that WES says it only has about 20% share of its addressable markets. In aggregate this might be provable, perhaps to ward off gnarly competition regulators. But it is probably more accurate to liken Bunnings to a mothership where all manner of activity can thrive to nurture its customers. Bunnings commands an estimated 60% of the paint market yet it has perhaps only 15% of the trade market and is barely getting started in petfood. Bunnings’ strategy is aimed at the ‘whole of home’ which incorporates just about anything material in a consumer’s daily life, although no longer includes filling your fridge and pantry as WES has now sold its remaining stake in Coles.
We noted that the pace of Bunnings network expansion (new stores and refreshes/upgrades/expansions) has slowed to just ~10 per year. This excludes the newly acquired Beaumont Tiles, Tool Kit Depot (TKD), Frame & Truss, and distribution and fulfilment centres, all of which have room for growth. The growth sauce for Bunnings is about store optimisation – focusing on the most profitable categories and expanding in new ones such as pet food.
A theme at WES has been its slow pace of development in online delivery and fulfilment. The company is trying to envelop all its brands to optimise the impact and the spend required to get there. WES is incurring losses of about $100m in its OneDigital retail ecosystem program after 18 months but this will eventually bear fruit through the cohesive use of customer data to assist inventory, promotion and marketing insights across the brands. So far this includes Kmart, Target, Catch and Bunnings and will eventually include Priceline and Officeworks. The OnePass membership is growing but is a long way behind Amazon Prime’s 2.9m members.
As part of this online strategy, WES will need to expand its distribution centre and fulfilment facilities which could cost more than $100m, in our view.
Lower ammonia prices will create a headwind for earnings in the WES CEF business (chemicals, energy, fertiliser and lithium). Ammonia prices are down ~70% from peak levels in March 2022. The Covalent partnership (with SQM) has almost completed the concentrator at Mt Holland while the Refinery is also making good progress. Covalent has executed agreements for lithium hydroxide with some key customers.
CEO Rob Scott’s media comments following the presentation centred on Australia’s declining productivity and rising cost pressures. WES faces higher energy and transport costs, while wage pressure is a key factor across the group where its FY22 wage bill was $5.8bn – as big as Westpac. Mr Scott has one eye on productivity and the other on changing industrial relations laws such as ‘same job, same pay’, and the rules on casual employment.
Mr Scott’s contention is that consumers are seeking value again now that the pinch of higher interest rates and inflation is curbing spending intentions. This certainly rings true for Kmart and Officeworks and to some extent, Bunnings. We noted with interest that around 60% of Kmart’s $9.6bn FY22 sales were from its own Anko brand. The Health segment, which crosses over into Kmart, is also centred on affordable beauty, health and medical categories. Priceline Pharmacy is a classic example of a business acquired by WES which can be transformed and expanded, not dissimilar to what has happened at Officeworks.
Investment View
As retail spending continues to shrink, WES is confident it can absorb the slower pace of sales through its key brands and offerings. This is probably true, but it does not escape the fact that sales growth is slowing across the group and therefore, so are earnings. We are seeing evidence that Bunnings’ sales growth is tapering and expect this to be the case heading into 2024. Bunnings is currently more focused on category expansion than store expansion.
WES’s PE ratio relative to the ASX200 is higher than its long-term historical average which is not currently justified given the volatility in earnings ahead. We expect sales growth to slow in Bunnings over calendar 2023 and for the WES PE to slip towards 20x FY24f EPS. Group earnings will also face some pressure from the decline in WES Chemicals, Energy and Fertiliser business as ammonia prices recede from unusually high levels. The Covalent lithium business is yet to contribute to profit as it continues to build its capacity in lithium chemical processing.
Risks to Investment View
Interest rates may not remain high for as long as expected, which would boost consumer confidence and retail sales. WES’s capex for online might be larger and take longer to generate acceptable outcomes. WES has a history of acquisition (and divestment) with the most recent examples being in healthcare and lithium. There is risk involved in extending the portfolio, particularly into new businesses although WES has a strong track record in this regard.
Recommendation
We have retained our Sell recommendation.
Figure 1: WES PE RATIO RANGE
