Coal a drag but Wesfarmers still rock solid
The Wesfarmers share price received a bit of a slap around as analysts and investors focused (naturally) on the giant Coles food and liquor business. The investment crystal ball gazers had been hoping that on a same-store basis the food and liquor operations would grow sales beyond 4 per cent.
Instead the division notched up gains of 3.9 per cent for the second quarter - a result that would have been better without the drag of the chronically troubled liquor segment, which by the way will not move into positive-contribution territory for another year at least. To the extent that Wesfarmers' food and liquor division fell short, it wasn't by much, and investors must also be wary of quarterly stats that can move around a bit and don't necessarily make a reliable trend.
The reason the market should be concerned about Wesfarmers has little to do with the retail operations, or the fertiliser division or even the insurance business (which appears to be relatively unaffected by the Queensland floods). The real concern is Wesfarmers' coal business, which appears to be running at a loss at current prices for sales of all but premium-grade product.
Wesfarmers boss Richard Goyder seems confident enough that market forces will ultimately improve this business as either supply will fall or demand will improve. But until this happens this division's contribution to group profit will be under severe pressure, and this is despite it being a relatively low-cost producer.
The nature of a conglomerate is that some divisions will fire and compensate for the cyclical declines of others - certainly this is the Wesfarmers credo. Overall, the company should be looking at earnings growth for the year of around 4 to 5 per cent before interest and tax.
Given the company is seriously weighted to retail, it is understandable that investors are micro-analysing this part of its performance. Taking all its retail businesses into account, Wesfarmers improved sales for the quarter by 4.6 per cent, which, according to Macquarie Equities analyst Greg Dring, is 1.3 times the retail industry, based on Bureau of Statistics data.
Of course, Wesfarmers has the advantage of being in the non-discretionary sector, where poor consumer sentiment is less of a factor.
But if you are an investor putting your money in a business that has some immunity from consumer sentiment, Coles is not a bad place to be. Shareholders have already worked this out.
One of the major reasons Wesfarmers' shares were sold off is that the price has already factored in the upside.
The company is now trading on a prospective price earnings ratio of nearly 20 times. While it has plenty of growth left, there is probably not enough to justify these hefty multiples under normal circumstances.
Investors are more likely to be looking at Wesfarmers as a safe-yield stock - delivering about 4.5 per cent. Again this is nothing to get excited about, but it's better than the cash rate with less risk than many other shares.
Goyder made a strong suggestion that expectations are for improvements in profits as more work is done on taking costs out of the business. At the very least, improving the liquor business would provide an earnings boost.
When it comes to investing it is all about relativities and comparisons. Across the broader market, it is only the banks, Telstra and maybe some healthcare companies that can be relied on to deliver the low-risk returns of Wesfarmers.
Kmart is also continuing to improve its performance, despite the subdued retail conditions, and, as usual, Bunnings produced a stellar result.
Target, however, has again demonstrated that it has not found its market position, with comparable store sales still sliding, albeit not by much in the quarter. It is also feeling the pinch from a general decline in the electrical and entertainment segment.
The focus of attention will now be on Woolworths and the extent to which it can mount a comeback - both in supermarkets and Big W.
Most experts take the view that the percentage increase in Woolworths' food and liquor business (which it will announce on Thursday) will fall marginally short of that produced by Wesfarmers.
However, Woolworths is a larger business and in dollar terms the improvement in sales may exceed that of Coles' food and liquor in the quarter.
Frequently Asked Questions about this Article…
The article says investors and analysts homed in on Coles’ food and liquor results — the division posted same-store sales growth of 3.9%, just under the hoped-for 4%+ level — and worries about the coal business. While retail results were generally solid, concerns about coal running at a loss (except for premium-grade product) and already high valuation helped pressure the share price.
According to the article, Coles’ food and liquor business recorded 3.9% same-store sales growth for the quarter. The liquor segment acted as a drag on performance and is not expected to move into positive-contribution territory for at least another year.
Yes. The article highlights that Wesfarmers’ coal division appears to be running at a loss at current prices for all but premium-grade coal. That puts pressure on the division’s contribution to group profit, even though it’s described as a relatively low-cost producer. CEO Richard Goyder expects market forces (lower supply or stronger demand) to eventually help, but the near-term impact is a concern.
Wesfarmers’ total retail businesses improved sales by 4.6% in the quarter. Macquarie analyst Greg Dring noted this is about 1.3 times the retail industry rate based on ABS data. The company is expected to target group earnings growth of roughly 4–5% for the year before interest and tax.
The article describes Wesfarmers as a 'safe-yield' stock delivering about a 4.5% yield — higher than the cash rate and with less risk than many shares. However, it also notes the shares trade on a prospective price-earnings ratio near 20, so yield-seeking investors should balance income against valuation and growth prospects.
The piece reports Kmart is continuing to improve despite subdued retail conditions, Bunnings produced a stellar result, while Target is still struggling — comparable-store sales are sliding (albeit slightly) and Target is feeling a decline in the electrical and entertainment segment.
The article suggests Woolworths may be improving and could give Wesfarmers a run for growth. Most experts expect Woolworths’ percentage increase in food and liquor to be marginally below Wesfarmers’ Coles, but because Woolworths is a larger business, the dollar improvement in sales for the quarter might exceed Coles’ gains.
Wesfarmers boss Richard Goyder signalled confidence that market forces will help the coal business over time, and the company is working on taking costs out of the business. The article notes that improving the liquor business and further cost reductions are expected to provide an earnings boost.
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