By Paul Rickard

The market was pretty savage on Wesfarmers yesterday following the release of its first half result, sending the shares 4.9% lower to close at $41.50. However, for the conglomerate that owns Coles, Bunnings, Kmart, Target, Officeworks and an industrials division that includes chemicals, fertilisers and coal mines, the movement needs to be seen in context. Firstly, it was a pretty tough day overall, with the S&P/ASX 200 shedding 2.1%. Moreover, Wesfarmers has been one of the better performing stocks this year on the ASX.

Despite yesterday’s fall, Wesfarmers is only 0.27% lower than where it finished 2015, which compares to the broader market’s loss this year of 7.95%. And according to FN Arena, it sits above the broker consensus target price of $40.72.

So when a company delivers a result that in aggregate is largely as expected, but highlights  ongoing challenges in one division and is coming off a period of strong market support, it is not surprising that the first reaction to the news is for some profit taking.

Wesfarmers first half

Overall net profit after tax of $1.393bn, an increase of 1.2% on the same half in 2015, was just a fraction shy of broker forecasts. Strong performances in Coles, Bunnings, Officeworks and Kmart were offset by the loss in the resources business.   

 

As the following table shows, growth in EBIT for Coles, Bunnings, Officeworks and Kmart of $172m was almost wiped out by the performances of the Safety and Resources divisions. The latter slipped to a loss of $118m for the period compared to a profit of $35m in 2015.

And unfortunately, the outlook painted by Wesfarmers for the Resources division remains gloomy. Not only will it be impacted by the challenging near term outlook for export coal pricing, production slippages due to adverse weather and locked-in currency hedge losses will affect the second half result. 

On the positive side of the conglomerate’s ledger, Bunnings, Officeworks and Kmart starred. Bunnings lifted earnings by 13.4% to $701m, and boosted its return on capital to a very impressive 35.8%. At the rate Bunnings is growing, it won’t be too long before its contribution approaches the massive Coles supermarket and convenience store/petrol retailing business, where earnings increased by 5.6% to $945m.

In the newly named ‘department store’ business, Kmart lifted earnings by 10.4% to $319m, and reported a return on capital of 36.2%. Target also had an earnings lift of 5.7% to $74m, but showing the challenges in running businesses of this nature, still only returned 3.8% on the capital employed. No surprise then that Managing Director Richard Goyder announced a restructure of the department store business to bring it all under the one roof, with present Kmart CEO Guy Russo to head it up. Target MD Stuart Machin will move into a new “senior role” in the group.

Sales results point to continuing tough times for Woolies

Accompanying the half year results were sales results for the second quarter. For Coles,   comparable store sales in food and liquor were up by 4.9% on the corresponding quarter in 2015, compared to a first quarter rate of increase of 3.6%. Woolworths, which saw comparable store food and liquor sales decline by 1.0% in the first quarter, will report its second quarter result on Friday.

Bunnings lifted store on store sales by 7.6%, while Kmart reported a 9.5% increase in second quarter sales. Target, which is starting to feel a little like BigW, recorded a 0.2% increase in comparable store sales growth.

ABS retail turnover figures for the Australian economy have been relatively flat, growing at only 0.6% in the December quarter following a rise of 0.5% in the September quarter. With both Coles and Kmart lifting the rate of sales growth in the second quarter, it is possible, but unlikely, that Woolworths will report much improvement on Friday to its anaemic first quarter result and  close the sales gap on Wesfarmers.

Wesfarmers or Woolworths? 

Woolworths had 4 major challenges to address. Close or sell Masters, fix Big W, get a new CEO and most importantly, get some momentum back into the mainstream supermarkets’ business as it fights Coles, Aldi, IGA and possibly Lidl. 

We got a decision on Masters (which is real progress), but we don’t know how hard or costly it will be to complete the exit. Grant O’Brien resigned way back in June last year, but more than 8 months later, the Group is still without a CEO.  We keep hearing that BigW has turned the corner, but the sales and financial results tell another story. And over at supermarkets, Coles continues to take share from Woolworths.

 

Woolworths will be outstanding value at some stage, but I still think it is too early to buy. Maybe Woolworths will surprise on Friday with the announcement of a new CEO or progress in getting BigW or the supermarkets’ business back into shape, but following the Wesfarmers result, the odds against this appear to be growing. On a multiple basis, there isn’t that much too choose between the two companies. Wesfarmers is trading at 18.5 times FY16 earnings, while Woolworths is at 17.2 times. Notwithstanding the challenges the conglomerate has with its resources business, I am still in the Wesfarmers camp.