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Should you buy Wesfarmers Ltd after its MASSIVE write-down?

Somewhat surprisingly Wesfarmers Ltd’s (ASX: WES) shares have rallied around 2% today after announcing to the market that it will write-down the value of goodwill apportioned to its discount department store (DDS) chain Target by $680 million pre-tax.

In many ways the write-down comes as no surprise considering the poor performance of the Target business in recent years. For comparison, in the half-year ending December 2013 Wesfarmers’ two DDS businesses Target and Kmart made $2 billion and $2.3 billion in sales respectively. While top line revenues were reasonably similar across the two brands, the earnings before interest and tax (EBIT) couldn’t have been more different, with Target earning just $70 million compared with Kmart’s $260 million!

As bad as this write-down is, one of the more alarming points to come from Wesfarmers’ announcement was FY 2014 guidance for Target’s EBIT to be in the range of $82 million to $88 million. This suggests very weak second-half earnings for the division and that there is still a long way to go before the business is earning an acceptable return.

Most likely aiming at front-running critics, Managing Director Richard Goyder was quick to point out that the value created in the other parts of the acquired Coles Group far outweighed the write-off within the Kmart business.

For some investors this may be ‘the last straw’

Wesfarmers has underperformed both the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) and rival Woolworths Limited (ASX: WOW) over the past year which may have some shareholders questioning if they shouldn’t be invested elsewhere. It should be remembered however that this write-down is a ‘non-cash’ item. Of greater importance is judging the company’s overall return on investment from the Coles Group acquisition, and considering whether there is scope for the coal division to improve its earnings and also how the cash from sale of its insurance division will be utilised.

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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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