Bunnings dominates Wesfarmers’ earnings, even more so following the exit from Coles, but the homewares powerhouse is out of puff. We think Bunnings’ earnings will be flat for the next three years unless it can address the online weakness and improve its trade share.
As sales growth slows at Bunnings, we expect WES to de-rate. After a strong period of growth during the pandemic, we think sales growth will slow down for Bunnings. On the current strategy, we think sales growth will average 3% pa over the next three years with no change in margins. If this scenario plays out, we think WES FY24f earnings per share is about 10% below the consensus forecast.
An issue we see in Bunnings is a low penetration rate for online sales. At the 1H22 result, Bunnings reported its online penetration as 4.3% of sales compared to the US-listed Home Depot at 13.7% in FY21. Bunnings has said that about 85% of its online sales are ‘click and collect’ with trade sales being encouraged by the further development of a commercial website.
Bunnings has specifically said it can grow its share of trade customers. This is certainly achievable, but this customer segment requires different supply and service arrangements for some categories. Approximately 35% of Bunnings’ sales are to trade customers.
The majority of Bunnings’ products are delivered direct to stores. In recent years, Bunnings has directed most of its capex to its stores, averaging $475 million pa (excluding property) in the last 3 years, or about 1.6% of sales.
If Bunnings decided to increase its distribution capability to facilitate greater online sales, we think it would need to spend somewhere around $1.4-2.0 billion to create a suitably sized DC fulfilment model.
The disadvantage of direct to store deliveries includes higher costs embedded in the product range, potentially higher inventory holdings and difficulty executing online, particularly for high volume items. The 10-year average PE premium for WES has been about 25% to the ASX200 Index. The PE premium expanded in 2020 and 2021 given the very strong sales at Bunnings. We see sales as normalising over the next few years which will bring WES’s PE rating back to around 19x FY23f eps.
Investment view
Bunnings has been a colossus in terms of its growth and earnings power, so a period of flat or even negative growth is hard to fathom. Currently, Bunnings represents such a large proportion of WES’s earnings that if growth stagnated in the homewares business for a couple of years, this would be negative for the WES share price.
The caveat to this scenario is if Bunnings was to address the weakness in its online offer, and/or improve its trade share. Our base assumption is that this does not occur, despite the very strong WES balance sheet. Conversely, if WES did commit to investing in more online capability and targeted a larger share of the trade market, the return on investment would take time to accrue.
WES has expanded its portfolio into healthcare and lithium with the recent acquisitions of API and Mt Holland respectively. These assets will compete for balance sheet capacity within the group although we note that WES is currently underleveraged with net debt of just $2.7 billion as at 31 December 2021.
Risks to investment view
Higher interest rates and inflation could affect consumer confidence and spending in the next year.
Recommendation
We have lowered our recommendation to Sell from Hold.
