Market favourite Wesfarmers Ltd (ASX: WES) sells at 21 times earnings; usually a sign of high growth prospects. However if we dig down just a little, we find:
1) The 5 year growth in earnings per share totals just 23% compared with a growth in market capitalisation of 77%. This factor alone calls Wesfarmers as seriously overbought.
2) 2013 net return on equity was a mere 12.6% with broker consensus predicting 14.4% in FY2015. By comparison Woolworths has a net return on equity of 35%.
3) With a high dividend payout ratio of 87% Wesfarmers is not positioning itself for significant future growth – unless partly funded by dilutive share issues.
4) The divestment of the underwriting insurance business raises the possibility of acquisition risk; with market gossips opining Wesfarmers has people in Asia and other places looking for potential targets.
Although Wesfarmers has interests in metallurgical coal, fertilisers and safety equipment the bulk of revenues and profits are generated by the retail division – and here we have a mixed bag.
Coles (supermarkets, liquor stores) grew revenues 4.7% in the first nine months of this trading year. On face value this is fairly good although profit growth was largely achieved on the cost side and in particular supplier 'payments'. If proven, the current ACCC unconscionable conduct action against Coles during 2011 highlights the excessive ongoing supplier squeeze actioned by both major supermarket chains over recent years. Long live IGA and the independents!
In other retail the star on the stage is home improver Bunnings which enjoyed 11% revenue growth in the ¾ year. Bunnings generates 16% of sales and continues to grow. However this growth rate won't continue and the federal budget is a blow. Officeworks enjoyed a reasonable period with its 4% share of total sales.
Taken together, discount department stores Kmart and Target put in another sluggish performance and the budget is an additional net negative for this segment of the retail market.
In my view Wesfarmers may struggle to achieve earnings growth above 5%pa over the medium term. At $42.85 it trades well above my fundamental valuation ($25) and qualifies as a sell.
