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Is Wesfarmers a buy or a sell?

At first sight, buying a multi-business like Wesfarmers (ASX: WES) can be appealing. After all, it sells everything from coal to insurance, so if one division hits hard times, it should be counter-balanced by another on an upward curve. However reality doesn’t necessarily endorse theory. Let’s take a look at Wesfarmers’ major divisions.

Retail

We saw reasonable earnings growth at Coles, Bunnings, Officeworks and Kmart in 2013. Target continues to disappoint. Operationally, Bunnings was the highlight. Coles is, of course, the elephant in this room and ongoing strategies here include further improvements in supply chain efficiency, increasing the number of owned brands and opening new stores/outlets.

In 2013, Coles alone contributed 41% of total group earnings before interest and tax with Bunnings second on 26% and the remaining retail outlets 13%. In total, the retail division contributed 80% of group earnings before interest and tax – evidently Wesfarmers is a retailer and very much tied into the retail cycle and conditions.

The challenger here is Woolworths (ASX: WOW) an intense competitor with similar strategies, management capabilities and marketing reach. In such a situation margin growth can only be extracted by increasing efficiencies and reducing the costs of doing business – there are limits to this.

With volume retailers an alternative is to increase floor space or open new stores. However, Australia is already saturated with supermarkets and home improvement centres, leading to a state of diminishing returns.

Industrial (including chemicals, energy, resources and fertilisers)

Apart from chemicals, this division continues to experience lower demand and prices for a significant proportion of production. We should see some improvement in 2014, especially with a lower dollar. This division is responsible for 15% of group earnings before interest and tax.

Insurance

Insurance had a standout 2013 with the best underwriting result in seven years. Favourable claims experience and recent broking acquisitions contributed and further agency purchases can be expected. However, insurance only provides 5% of group earnings before interest and tax.

Foolish takeaway

Allowing for a 7% uplift, Wesfarmers ($41) is selling at 2014 projected earnings of 19.7 ($2.08 per share) and a franked yield of 4.7%. A capital return of 50c per share is anticipated balanced by a reduction in shares on issue.

The downside with Wesfarmers is that it is a company with a traditional retail-dominated portfolio of mature businesses. Operating in competitive revenue driven industries there is no potential catalyst to justify current market pricing.

In this Fool’s opinion, Wesfarmers is a sell.

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Motley Fool contributor Peter Andersen doesn’t own shares in the companies mentioned

 

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