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3 reasons why I don’t think the Wesfarmers Ltd share price is a buy

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The Wesfarmers Ltd (ASX: WES) share price hasn’t done much over the last five years and I don’t think it’s going to grow much in the next five years either.

Wesfarmers may be one of Australia’s largest retailers, which generates significant economies of scale, but I don’t think it’s a buy for the following reasons:

Saturated the market

Wesfarmers has expanded significantly over the last decade and it’s difficult to see where it can put many more Bunnings, Coles, Kmarts, Officeworks and Targets.

When a company has grown almost as much as it can it’s mostly relying on inflation and population growth to keep increasing its sales.

Price deflation

Coles is one of Wesfarmers’ key businesses. The supermarket has been attracting shoppers for years with its ‘down down’ campaign advertising that prices are permanently down on some products.

That may be great for customers, but it’s bad for Wesfarmers’ profit margins. If the profit is decreasing then the earnings per share will decrease too. The drop in profit for Coles detracts from the profit growth that Bunnings and Kmart achieve.

There is no sign that price deflation will stop any time soon. Woolworths Limited (ASX: WOW) and Aldi are also decreasing prices. It’s a fight to the bottom, which Coles will find hard to win.

More competition

The key reason why I don’t think Wesfarmers is a buy is competition.

The Aldi effect has been ongoing for some time and Coles’ margins are materially lower now.

However, there is also food competition from Costco and undoubtedly Amazon Fresh will try to get in on the action too.

Amazon will soon be launching its main shopping website here in Australia once it has found the distribution centres it needs. Amazon will cause a huge problem for Officeworks and Target. Bunnings and Kmart will probably be affected too, but to a lesser extent.

If US and European retailing is anything to go by, there won’t be many winners from Amazon’s arrival.

Foolish takeaway

Wesfarmers is trading at 16x FY17’s estimated earnings with a grossed-up dividend yield of 6.61%. I think it’s better priced than Woolworths but I don’t expect any growth over the long-term, which is why it’s on my avoid list.

Instead of Wesfarmers, I’d rather buy these growth stocks which are much more likely to deliver market-beating returns.

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Motley Fool contributor Tristan Harrison has no position in any stocks mentioned. The Motley Fool Australia owns shares of Wesfarmers Limited. 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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