Wesfarmers: Second half bounce back

About the author:

Author name:

By Alex Lu

Job title:

Analyst

Date posted:

29 August 2022, 7:00 AM

Sectors Covered:

Industrials

• Wesfarmers’ (ASX:WES) FY22 result was comfortably above expectations.
• Key positive(s): Kmart Group earnings recovered strongly in 2H22 after being heavily impacted by lockdowns in 1H22; FY22 DPS of 180cps was above our 164.8cps forecast and Bloomberg consensus (169.5cps); Group ROE rose 330bp to 29.4%.
• Key negative(s): Group EBIT margin dropped 120bp to 9.3%; Health division EBIT for the 3-months of ownership in FY22 was -$24m; Operating cash flow was down 32% due to higher working capital (predominantly inventory).
• Management said retail trading conditions have remained robust through the first seven weeks of FY23.
• FY23-25F group underlying EBIT changes by between -1% and +3%.
• Our target price falls to (login to view) and we maintain our Add rating. We continue to view WES as a core portfolio holding for long-term investors.

FY22 result was well above expectations

FY22 underlying EBIT fell 4% to $3,633m (+3% vs MorgansF and +6% vs Bloomberg consensus) and underlying NPAT decreased 3% to $2,352m (+6% vs MorgansF and +5% vs Bloomberg consensus).

Earnings in the retail divisions were mixed with Bunnings EBIT up slightly (+1%) while Kmart Group (-36%) and Officeworks (-14%) were weaker due to lockdowns in 1H22. The Industrials businesses had a good year with WesCEF EBIT up 41% on the back of higher commodity prices and Industrial & Safety EBIT rose 30%.

EBIT for the new created Health division (3-months) was -$24m which included several one-off charges. Excluding these charges, Health EBIT was $12m.

Bunnings and Kmart performed well

Bunnings FY22 EBIT rose 1% on the back of 4.8% LFL sales growth. While earnings were slightly below (-1%) our forecast, it was nonetheless a very good result, in our view, given the strong growth over the past two years (FY21 EBIT +18%, FY20 +19%).

EBIT margin fell 60bp to 13.1% due to operational challenges related to COVID and ongoing supply chain disruptions leading to some additional freight, demurrage, and storage costs.

The change in mix from higher Trade activity also had a negative impact on margins (Trade is slightly lower margin than DIY). For FY23, we forecast Bunnings EBIT to be down 3% to $2,248m.

While Kmart Group FY22 EBIT decreased 36% to $506m, the result was 23% above our forecast.

2H22 performance (EBIT +12%) was much better than 1H22 performance (-58%), which was significantly affect by lockdowns. Trading conditions improved in 2H22 as restrictions eased. For FY23, we forecast Kmart Group EBIT to be jump by 67% to $843m after cycling the lockdown impact in FY22.

Retail trading conditions remain robust

Management said retail trading conditions have remained robust through the first seven weeks of FY23. Sales growth has been particularly strong in Kmart Group, with sales significantly higher on both a one-year and two-year basis.

Bunnings also continues to see positive sales growth on a one-year and two-year basis. Sales in Officeworks were in line with the prior year. Overall, we forecast FY23 group underlying EBIT to increase by 5% to $3,827m.

Changes to earnings forecasts and investment view

We adjust FY23F/24F/25F underlying EBIT by +3%/-1%/-1% and underlying NPAT changes by -2%/-6%/-5%. The larger movement in underlying NPAT reflects a remodelling of net interest expense to include interest on leases (previously included in EBIT at the divisional level).

Our equally-blended (PE, SOTP, DCF) target price falls to (login to view) and with a 12-month forecast TSR of 20%, we maintain our Add rating.

Trading on 22.5x FY23F PE and 3.8% yield, we continue to see WES’s valuation as attractive for a high-quality business with a diversified group of retail and industrial brands, solid balance sheet and strong leadership team that will continue delivering long-term value for shareholders.

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