We anticipate a slowing sales profile and rising costs will shrink margins and earnings for Wesfarmers in FY23f.

COVID-19 costs and disruption fractured the retail businesses within WES although a sturdy 2H22 recovery delivered a mostly neutral outcome for the year.

Group EBIT of $3.6 billion was down 3.8% on FY21 but the composition, as always, was dominated by Bunnings where EBIT of $2.6 billion was virtually flat on last year. Bunnings margins fell at an accelerating rate and will be under pressure for the next two years as the business invests in staff, loyalty (Flybuys) and data capability.

Kmart Group earnings were horribly affected by COVID-19 impacts in 1H22 but staged a good comeback in the second half to be down just 3.5% on FY21. Kmart margins, in contrast to Bunnings, should rebound in FY23f.

Officeworks saw online penetration reach 40% across the year but the trend had eased as the store network got back to full capability in the back end of the year.

Capex increased 28% to $1.14 billion in FY22 of which $304 million was due to the Mt Holland lithium project (WES 50%). After net property sales of $260 million, net capex was $884 million. FY23f capex will be $1.0-1.25 billion including another $450 million at Mt Holland.

INVESTMENT VIEW

WES’s portfolio approach to investment paid dividends throughout the pandemic and the more recent global energy crisis. As retail stores were forcibly closed in 1H22, the commodities business at WesCEF was delivering record earnings as prices for fertiliser and LPG rocketed upwards.

Retail still dominates WES earnings, Bunnings particularly at 64% of group EBIT, yet the contribution from WesCEF was meaningful. It will get bigger too, as the Mt Holland lithium project works towards delivering its first production in 2H of CY24.

The pandemic sales boom is unwinding for retail just as costs are rising. Margins are under threat and therefore so are earnings for FY23f. COVID-19 costs are diminishing but the persistence of supply chain issues has forced inventory higher and labour costs are still troublesome.

WES owns 24.75% of BWP Trust (market value $636m) which owns 74 properties in the Bunnings property portfolio. BWP has been a steady contributor to WES’s ‘other’ divisional income over many years and turned in a very strong EBIT contribution in FY22 at $121 million.

A key issue for FY23f will be the sales profile for Bunnings. The retail aspect is expected to decline, but the company is hoping the commercial side will compensate. Competitor Metcash’s hardware division generates 64% of its sales to the trade, which may say something about where tradies prefer to shop. Metcash’s comparable sales growth in FY22 at 10.5% (year end 30 April) was starkly better than the 4.8% at Bunnings. The addition of Beaumont Tiles and Tool Kit Depot (formerly Adelaide Tools) brings a new dynamic, but these businesses will take time for the WES imprint to take hold. We expect Bunnings EBIT to be broadly flat over the next two years.

The portfolio has expanded to include a new division. Health consists of the API pharmacy distribution and Priceline businesses. Here again, it will take time for WES to invest in the long term plans such as expanding DC capability and e-commerce opportunities.

The company’s recent strategy briefing focused on OneDigital, the new division for the group’s digital and data assets. There will be plenty of investment (WES expects a loss of $100 million in FY23f) to leverage the fulfilment and breadth of offer as well as the cost of delivery. Amazon has a huge head start so WES will need to execute to a high standard if this business is to gain traction.

Risks To Investment View

Higher interest rates and inflation could affect consumer confidence and spending in the next year.

Recommendation

We have retained our Sell recommendation.

FIGURE 1: FY22 RESULT

FIGURE 2: WESCEF EBIT (CHEMICALS, ENERGY, FERTILISER)