3 things Wesfarmers Ltd must do in 2014

While still most definitely a conglomerate, Wesfarmers Ltd’s (ASX: WES) earnings base is now more concentrated on retailing, thanks to the recent sale of its underwriting operations. The sale means a significant cash injection for the firm, however with the stock trading on a forward multiple of around 20 times earnings, the company will need to continue to produce solid earnings growth to justify its pricing in 2014.

While there are a number of growth levers that management can pull, there are three areas that management will be focusing on in 2014.

1)  Capital Management

With the sale of Wesfarmers’ insurance underwriting operations to Insurance Australia Group Limited  (ASX: IAG) for $1.845 billion, Wesfarmers has removed its exposure to the risks associated with the underwriting business. Many investors will be pleased with this outcome as it removed a division believed to be subscale and also that had a higher level of risk.

More important to shareholders is how those funds will be redeployed from the sale to IAG. Acquisitions, dividends and capital returns are all possible uses for the funds, with a buyback an unlikely option given the current high price the stock is trading at.

It’s interesting to note that Wesfarmers sold the underwriting business but retained the broking operations. Insurance broking has proved very profitable for some, with listed peers Austbrokers Holdings Limited (ASX: AUB) and Steadfast Group Ltd (ASX: SDF) examples. It’s possible that in 2014 Wesfarmers could redeploy those funds into expanding its broking business possibly through further leveraging the Coles brand.

2)  Coles turnaround

While management has done a commendable job since acquiring the Coles business, many would suggest more is required before management can claim that Coles is on par with rival Woolworths Limited  (ASX: WOW). For financial-year (FY) 2013, Woolworths reported earnings before interest and tax (EBIT) to sales margin from its Australian food, liquor and petrol division of 6.83%. In contrast the Coles division reported an EBIT margin of 4.3%, suggesting there is still a lot to be done to catch up with Woolworths.

3)  Coal

Wesfarmers is of course a price taker and cannot influence the price of coal, however with divisional EBIT declining from $439 million in FY 2012 to $148 million in FY 2013 management will need to remain vigilant in 2014, to ensure cost minimisation and production maximisation.

Foolish takeaway

Wesfarmers is a great example of a company with a board and management team who act in the interests of their shareholders and make decisions based upon creating shareholder value.

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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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