5 reasons Wesfarmers should be on your watchlist

Diversified conglomerate Wesfarmers (ASX: WES) is well known to many investors. Indeed, it’s hard to ignore a company that is valued at $48 billion and owns some of the most recognised and frequented retailers in the country.

While Wesfarmers doesn’t appear to be a bargain at current prices, its turnaround strategy and improving outlook in a number of divisions should see earnings growth in financial year (FY) 2014, which helps justify the current share price.

1)  Retail turnaround

Buying the underperforming assets of the Coles group and turning them around hasn’t exactly been an easy task, with the recent poor performance of Target a glaring example. That said, Coles, Kmart and Target all have the potential to continue to expand their profit margins through improved operating efficiencies, even if revenue growth is hard to come by in the near term. Further margin expansion from these retail divisions would be a huge boost to Wesfarmers’ bottom line.

2)  Bunnings

Arguably the jewel in the crown, home improvement business Bunnings continues to produce outstanding levels of returns on capital at 25.9%. Revenue was up $500 million in FY 2013, while earnings before interest and tax (EBIT) increased by $63 million. Given the industry is still highly fragmented; Bunnings growth looks set to continue.

3)  Insurance

The insurance market looks to have stabilised after a couple of torrid years. EBIT bounced back from just $5 million to $218 million in FY 2013 with “further improvement in underwriting earnings expected in the 2014 financial year.” With Coles only having just ‘scratched the surface’ of its potential to cross-sell insurance products to its customer base, there is an enormous opportunity for Wesfarmers to boost revenues within its insurance division.

4)  Coal

Wesfarmers has exposure to coal, chemicals, energy (gas) and fertilisers. These are commodities whose prices are inherently volatile — particularly coal and fertiliser prices — meaning earnings from these businesses are very cyclical. While the near-term outlook is subdued, the long-term outlook for these businesses would appear to be sound and to provide upside for investors..

5)  Industrial & safety

This division suffered from a fall in earnings largely due to the slowing resource sector. While industry conditions are unlikely to improve in the near-term, the business is well placed to grow its market share compared to weaker players.

Foolish takeaway

A company of Wesfarmers’ size and diversity is always going to be facing headwinds in some part of its business. Investors who can look through these issues and take in the bigger picture could be well rewarded over the long-term.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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