Was the Wesfarmers full year result as bad as the headline numbers indicated?
On 15 August, Wesfarmers (ASX:WES) reported their full year earnings result. The result came in slightly higher than consensus, primarily as a result of a stronger performance from the discount department store businesses.
Actually, half of the upside surprise at the Earnings Before Interest and Tax (EBIT) line came from the divested resources and Bunnings UK (BUKI) businesses, so the underlying ‘beat’ was not as significant as the headline numbers indicated. Let’s take a closer look at some of the businesses under Wesfarmers.
Coles
Slightly better EBIT in 2H18 than our forecast despite weaker sales (i.e. higher margins). WES doesn’t provide gross margin (GM) and Cost of Doing Business (CODB) for Coles, and they hadn’t provided details on the convenience division EBIT either (other than the comment that it was down year on year), so the exact underlying EBIT for the core supermarkets and liquor businesses isn’t known.
Like-for-like (LFL) sales growth was 1.1 per cent for the half-year but accelerated to 1.8 per cent in 4Q18 and management commented that positive momentum has continued into 1Q19.
Cost savings however are expected to be offset by the full-year impact of the increase in wages under the new Enterprise Bargaining Agreement (EBA) in FY2019, so margins are likely to be pretty flat (in the absence of a GM lift).
Capex in FY2019 is expected to be between A$600 million and A$800 million. While this appears to be higher than the A$762 million reported in FY2018, it isn’t as big a step up as we would have expected given our current expectation that Coles will need to enter a large-scale store refurbishment cycle.
Bunnings
Roughly in line result at the EBIT line but LFL sales growth is slowing on a sequential basis. Management is also flagging a lower LFL in 1H19 relative to the 9.0 per cent recorded in 1H18. Keep in mind this should be expected given the previous corresponding period (1H18) sales growth benefited from capturing business from the closure of competitor Masters. Given sequential LFL sales are slowing and given 4Q18 was 4.9 per cent, some analysts may have to reduce their forecasts.
Keep in mind our previous discussion about national Alteration & Addition demand leading indicators, such as housing activity (house sales volume) and renovation mortgage applications, slumping.
Department Stores
The main driver of the company’s earnings surprise came from Target moving back into profit (management did not disclose the profit amount). The profit could be attributed to improved product sales mix, reduced markdowns, lower shrinkage and increased direct sourcing, and was achieved despite LFL (-5.1 per cent) and total sales (-4.7 per cent) continuing to decline year on year.
Kmart’s sales were up 8.0 per cent with LFL up 5.4 per cent. This is pretty consistent with its performance in 1H18 (total sales 8.6 per cent, LFL 5.4 per cent), although there was a slowdown in LFL in 4Q18 at 4.1 per cent (Easter adjusted).
Target’s LFL and total sales declines was an improvement on the LFL sales of -6.5% and total sales decline of 6.2 per cent in 1H18. 4Q18 LFL declined 3.0 per cent (Easter adjusted) showing the sequential improvement.
The Montgomery Fund own shares in Wesfarmers. This article was prepared 03 September 2018 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Wesfarmers you should seek financial advice
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
