Is Wesfarmers overvalued?

Wesfarmers (ASX: WES) is a $50 billion giant conglomerate which has operations spanning retailing – including supermarkets (Coles), discount department stores (Target and Kmart), liquor, home improvement (Bunnings), office supplies (Officeworks) – coal mining, industrial and safety product distribution and chemicals and fertiliser manufacture.

In the past few weeks Wesfarmers has announced the sale of both its insurance division and its WA-based joint venture gas processing and supply business. These two sales will reduce the number of operating divisions of the group and return around $2 billion in cash to the company. While there is every chance some of this cash will be returned to shareholders, given the company’s acquisitive nature and history of creating shareholder value there is a high chance much of this cash will be put towards value enhancing opportunities.

Despite the positive outlook for Wesfarmers’ businesses, the strong performance of its share price over the past year has seen the stock rise from around $37.70 to $43.40 – a return of 16% – potentially making the stock expensive. That’s certainly the opinion of analysts at research house Morningstar with the Australian Financial Review reporting that Morningstar has a long-term fair value of $37. Morningstar was positive on the sale of the insurance division, viewing the division as sub-scale and only “delivering low single-digit returns averaging 6.6 per cent during the last five years”. However in their opinion this would appear to be more than reflected in the current share price.

Foolish takeaway

It’s a difficult time for investors as we enter 2014 after a strong run-up in share prices. Wesfarmers is far from the only high quality business that looks to be trading at a full valuation. Other blue chips trading on hefty multiples compared to their earnings growth outlook include Woolworths (ASX:  WOW), CSL (ASX: CSL) and Coca-Cola Amatil (ASX: CCL). These high valuations could make it difficult for capital gains to be as strong in 2014 as in 2013.

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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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