The bargain hunter’s guide to Wesfarmers Ltd shares

Photo credit: AS 1979

While some investors might argue that anytime is a good time to acquire shares in blue chip stocks such as retail conglomerate Wesfarmers Ltd (ASX: WES), I would suggest that even purchasing blue chip stocks requires careful analysis.

One need look no further than the devastating capital losses experienced by shareholders of so-called blue chip stocks such as BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) to be reminded that blue chip status does not assure an investor of a trouble free holding.

With due respect to downside risk in mind, right now may be the perfect time to consider buying shares in Wesfarmers for the following reason…

It’s all about Bunnings

For the six months to June, Wesfarmers reported group earnings before interest and tax (EBIT) of $2.1 billion. The Bunnings Home Improvement division contributed $701 million of EBIT, implying that Bunnings was responsible for around one-third of total group earnings – a very significant contribution!

Of added importance was the growth rate in EBIT for the Home Improvement division. Whilst Coles is still the single largest contributor to group EBIT, Coles only grew at a 5.6% rate for the half. In contrast, Bunnings achieved a 13.4% growth rate on the prior corresponding half.

Amazingly, if Bunnings can continue to grow at a double-digit rate – a situation made all the more possible thanks to the demise of Masters (owned by Woolworths Limited (ASX: WOW)) in a few short years, Bunnings’ domestic business could conceivably be an even bigger contributor to group EBIT than Coles!

More growth to come

In January Wesfarmers announced the proposed $705 million acquisition of UK home improvement retailer Homebase. Homebase has 265 stores throughout the UK and Ireland and is set to be used as the launching pad for the Bunnings brand into these new overseas markets.

Given the size and high fragmentation of the UK home improvement market it’s certainly not inconceivable that Bunnings, in time, may achieve a similar scale of operation in the UK as it currently has in Australia. While that would certainly require significant growth from the roughly $49 million in operating profit that Homebase currently earns, in time it could happen.

Should Wesfarmers ultimately be successful in significantly growing the earnings contribution from Bunnings, this would (all else equal) require a meaningful increase in share price to reflect the higher profit base.

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Motley Fool contributor Tim McArthur has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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