The big question mark over Wesfarmers' next corporate play

Wesfarmers’ strategy day presentations didn't resolve the big question mark that pervades any discussion about the big retail-based conglomerate. If anything, they have enlarged it.

Even before Wesfarmers sold its insurance businesses, generating about $3 billion of cash and $1bn of profit, there was an anticipation that the group was approaching the moment of its next big corporate play.

Its retail businesses -- Coles, Bunnings, Kmart and Target  -- are (with the exception of Target) performing strongly and throwing off a lot of cash even though all of them, including Target, retain substantial potential upside.

Incoming Coles’ chief John Durkan made it clear in his presentation that the Coles food and liquor businesses are still a long way short of being world class, while Wesfarmers chief executive Richard Goyder talked about leveraging Coles’ established growth platform.

With the receipt of the proceeds of the insurance operations and the continuing recycling of its retail properties, Wesfarmers will be awash with balance sheet capacity. It will also be probably have a more concentrated portfolio that at any time in its history as a conglomerate.

Goyder is coy about what Wesfarmers might do next, other than that it is committed to its conglomerate strategy and that it is actively looking at options for "value-adding" transactions.

The transfer of the highly-regarded Ian McLeod from Coles into a vaguely-defined corporate head office role has heightened expectation that Wesfarmers will exercise one of those options in the near term.

The history of the group has been marked by transforming deals. It would require a large transaction to dilute its heavy exposure to domestic retailing and make it more of a genuine conglomerate.

Goyder, pointing to the influx of international retailers into the group in recent years, did talk about building the capabilities to expand offshore. However, he put that ambition into a long-term context rather than anything immediate. Wesfarmers has established a business development office in Hong Kong.

He also referred again to Wesfarmers’ interest in digital opportunities, an area to which McLeod is expected to devote significant attention.

It is arguable that Wesfarmers does need to do something substantial, regardless of whether or not it is a diversifying transaction.

It has an increasingly conservative and therefore under-utilised balance sheet at a time when the cost of debt is historically low. It also has a share price trading around record levels and therefore a cheap and attractive currency for acquisitions.

The alternative would be to embark on a major capital management program. While it might make sense to leverage the opportunity to borrow cheaply to fund a big restructuring of the group’s capital base, the notion of buying back shares trading at their current levels wouldn’t quite as compelling for Wesfarmers’ very disciplined finance director Terry Bowen.

However it chooses to deploy its balance sheet capacity, shareholders would be reassured by the group’s extremely successful turnaround of the distressed retail brands it acquired in 2007, the stellar ongoing performance of Bunnings and the discipline the group demonstrated with the exit from the insurance sector. 

That tends to demonstrate the continuing competency and financial discipline of the organisation.