By Paul Rickard

New Wesfarmers boss Rob Scott, who will take over from outgoing Managing Director Richard Goyder next month, has a big job in front of him. Yesterday, Wesfarmers released its September quarter sales and production results which showed that the conglomerate has its problem children.

Wesfarmers largest division by earnings, the Coles supermarket division, only managed to grow food sales in the 1st quarter of the year by 0.3% compared to the same quarter last year, down from a growth rate of 0.6% in the final quarter of 2016/17 and an average of 1.0% for the year. Arch competitor Woolworths, which is due to report quarterly sales figures on Monday, has already advised the market that for the first eight weeks of the quarter, it grew food sales at around 5.4%. While Coles pointed to the impact of price deflation, particularly with fresh produce, being beaten by such a big margin is in the embarrassing category.

For shareholders, it has probably also come at the expense of margin as the supermarket wars continue to rage.

Comparable Store Sales Growth

 * Adjusted for the timing of Easter

Problem child Target continued its horror run, with sales falling by 6.4% compared to the corresponding quarter 12 months earlier. Wesfarmers is working hard on the “reset” of Target product, price and range, but it is yet to show up in increased customer purchases and more losses can be expected.

Although it is too early to label the  purchase of the 244 store Homebase hardware chain in the UK a mistake, it looks like it is going to take some time before “Bunningsisation” pays off. Store on store sales decreased by 11.9% in the quarter. Bunnings Group Managing Director Michael Schneider admitted that “the performance of Homebase is disappointing”, but was encouraged by the early success in the UK of the first 8 Bunnings Warehouse pilots.

Stars in the Wesfarmers conglomerate included Bunnings Australia and New Zealand, which grew sales by 10.8% in the quarter, the Kmart department stores and the previously “unloved” Officeworks, which lifted sales by 7.8%.

If current trends continue, it is not that far away before Bunnings in Australia and NZ contributes more to group earnings for Wesfarmers than Coles.

Wesfarmers also released production figures for its coal mines. While total coal production in the September quarter for its Curragh mine was down 1.6% on the June quarter, the twelve month figures for the year to September showed an increase of 25.6%.

Buy or sell?

Wesfarmers shares have traded in a very tight range over the last 12 months, from a high of $45.60 to a low of $39.52. Following a fall yesterday of 2.9% to $41.49, it currently sits mid- range.

Wesfarmers (WES) - Oct16 to Oct17 (source CommSec)

Over the last two months, Wesfarmers shares have marginally outperformed Woolworths. This is partly because expectations for Woolworths were too high, but also the market recognizing that Wesfarmers was trading on a significantly lower multiple.

That said, the major brokers see Wesfarmers as fully valued and are not that positive on the stock. According to FN Arena, of the eight major brokers that analyze the stock, there is only one buy recommendation (from Macquarie). There are four neutral recommendations and three sell recommendations. 

The broker consensus target price is $41.09, a 1% discount to yesterday’s closing price.

Comparing Wesfarmers to Woolworths, the brokers still have Woolworths trading on a higher multiple of forecast FY18 earnings (20.4 times versus 16.4 times for Wesfarmers). They see earnings growing more strongly at Woolworths as the recovery in the supermarkets business continues, and Woolworths gets on top of its problem child (Big W). This results in the multiples narrowing in FY19. Like Wesfarmers, the brokers don’t see much upside in the price, with the consensus target price of $26.27, a 4.4% premium to yesterday’s closing price.

Trading Multiples (Wesfarmers and Woolworths)
 

Bottom Line

I can’t get excited by either Wesfarmers or Woolworths and think that this is a sector to remain underweight. If I had to choose one, I prefer Wesfarmers because it is still significantly cheaper, it is paying a higher yield, and arguably, the conglomerate model can add strength and reduce volatility.

The UK acquisition is a concern and needs to be kept under close security. For now, I think you have to give Wesfarmers management the benefit of the doubt and sufficient time to make it work. But it is off to a wobbly start and the clock is ticking.

For the time being, I can’t see Wesfarmers breaking the trading range. Buy in the high thirties, sell in the mid forties.