Given that almost $400 million of earnings within its coal business and Target disappeared during the year, the 6.3 per cent increase in Wesfarmers’ profits last financial year is a more than creditable achievement.
In fact, the $579 million capital return Richard Goyder announced today signals the group’s conviction that its underlying performance and its cash generation in particular is surging in a sustainable way. The group’s operating cash flows were up 8 per cent to $3.93 billion.
It’s also, perhaps, a signal that the group is entering a slightly different phase after years of heavy investment in rehabilitating the suite of run-down retail brands it acquired back in 2007.
The resurgence of Coles and Kmart has been remarkable and still has considerable momentum and the pre-existing Bunnings hardware chain, after accelerating its expansion and fine-tuning its offering to pre-empt and counter the launch of Woolworths’ Masters business, is producing solid growth.
Target remains a problem child and is expected to continue to struggle through the first half of the current financial year as it continues to clear stock and absorb the costs of its restructuring under the newly-appointed Stuart Machin. It is unlikely to be a quick turnaround.
More particularly, and the capital return provides a signal of this, the surge in investment in property that was associated with the Coles’ restructuring and Bunnings’ expansion has peaked and the level of recycling of Wesfarmers’ retail properties is accelerating – Wesfarmers released $659 million from property sales in the year just ended and that’s likely to continue, releasing both cash and capital.
It is also notable that Wesfarmers’ has significantly reduced the amount of working capital within its retail businesses as their sales continue to grow, their sourcing becomes more efficient and their inventory control continues to improve. It released more than $500 million of working capital from those businesses last year.
Goyder would still be unsatisfied with his overall return on capital, which improved from 8.4 per cent to 8.9 per cent, although the capital return, the focus on working capital and the continued recycling of retail properties will help sharpen that this year.
He would, however, be very pleased with the continuing strong performance of Ian McLeod and his team at Coles, who generated a 13.1 per cent lift in earnings before interest and tax to $1.53 billion and lifted their return on capital from 8.7 per cent to 9.5 per cent.
They have doubled their EBIT over the past five years, increased their EBIT margin by nearly two percentage points to 4.9 per cent, added 440 basis points to their return on capital and appear to still have considerable upside as the business shifts from restructuring mode to growth mode.
Kmart, which was nearly a dead brand when Guy Russo was given charge of it, lifted EBIT 28.4 per cent to $344 million, has an EBIT margin of 8.3 per cent and improved its return on capital from 18.9 per cent to 25.9 per cent on very modest sales growth.
Bunnings produced a 7.5 per cent lift in earnings, lifted its EBIT margin slightly to 11.7 per cent and maintained its stellar return on capital of 25.9 per cent. After $2.1 billion of investment in the business over the past four years the focus is still on network expansion but the pick-up in the pace of property recycling should protect and enhance its return on capital.
Bunnings’ John Gillam also oversees the Officeworks business, which generated a 9.4 per cent increase in earnings, increased its margins and added 100 basis points to its return on capital, to 8.1 per cent.
Target was, as expected, the blot on the Wesfarmers’ retail copybook, with earnings down 44.3 per cent to $136 million. Machin was despatched from Coles to fix the business, where costs had blown out and the retail offer had become confused. It will take some time to see whether the brand can be stabilised.
Goyder would also be happy with the rebound in his insurance business and reasonably sanguine about the downturn in coal earnings, from $439 million to $148 million, given the division has been impacted by the difficult conditions and lower prices within the coal industry generally. The problems within the resources sector, generally, also affected Wesfarmers’ industrial divisions.
Wesfarmers says it is optimistic about the outlook for its businesses despite the expectation of "challenging" domestic conditions, with the turnarounds within Coles, Kmart and Officeworks and the continuing strong performance of Bunnings providing platforms for future growth.
The capital return and a 9 per cent increase in the annual dividend, to $1.80 a share, are a tangible expression of the confidence that there is significant upside within those retail businesses that now, given the downturn in resources and resource-related activities, generate about 80 per cent of the group’s earnings.