In Japan and Korea, conglomerate style businesses are common. In fact, it is not uncommon to find huge sprawling businesses in these countries that have mining, retailing, shipping, banking and even consumer restaurant businesses operating under the same corporate banner.
In Australia, however, truly diversified conglomerates are rare, with many businesses choosing to specialise or operate in closely related fields.
Which makes Wesfarmers Ltd (ASX: WES) something of a uniquely listed business in Australia. While it is best known for being the parent company of Coles, it is also one of Australia's oldest businesses, with close to a century of history of operation before it bought the supermarket brand.
That makes investing in Wesfarmers something of a complicated exercise, as you are not just buying a part share in one business, but a part share in a whole portfolio of businesses.
To make things simpler, we've broken down Wesfarmers into its parts, and given each part a "grade" like you would see on a report card to help you better understand the strengths and weaknesses of the parts that make up the whole.
Coles – Grade: B+
Coles is the largest contributor to Wesfarmers group revenue, contributing over 60% of the $62.4 billion total turnover in 2014-15. The position of Coles in the Australian supermarket landscape is unquestionable, with it one-half of the entrenched duopoly that dominates the sector.
With the high profile struggles of chief rival Woolworths Limited (ASX: WOW), Coles has capitalised and smashed the Fresh Food People in same-store sales growth every quarter for years. Helped along by clever (and sometimes intensely annoying) marketing and targeted price reductions, Coles has weathered the aggressive expansion of Aldi much better than its large rival.
However, it will not be immune to future price wars as the German discounter expands its national footprint and reinvests profits in reducing prices even further. In addition, the struggling liquor operations also fall under the supermarket portfolio, and over a decade the First Choice and Liquorland businesses have failed to make a dent in the dominance of the Dan Murphy's brand.
Bunnings – Grade: A+
Undoubtedly the strongest business in the Wesfarmers portfolio, Bunnings as a standalone business would be one of the most attractive on the ASX. Prime geographic positioning for its stores, a multi-billion dollar addressable market, strong acceptance by its target customers, and high margins and returns on equity make for a fantastic business.
These attributes have seen Bunnings consolidate the highly fragmented hardware and retail building supplies market over the last decade, and so far, see off a well-funded potential competitor in Masters without any discernible effect on profitability.
Officeworks – Grade: A-
Officeworks works on a simple business model. It buys goods in bulk and secures discounts by focussing its purchasing power on certain product lines. It then passes these cost savings on to customers and creates a place where goods in that segment are consistently cheaper.
As a result, it has a higher level of "foot traffic" through its stores, and uses this to sell higher margin products (printer ink, office furniture) alongside its cheaper, higher turnover categories (stationery, office supplies). In a small market like Australia, there is realistically only space for one large player in a niche segment such as this one, and Officeworks occupies this position comfortably.
Kmart and Target – Grade: B-
Kmart and Target operate in the highly competitive discount department store space. Both have struggled with positioning in the market and the continual erosion of margins that come from trying to attract market share on a disparate range of consumer goods.
Given the high proportion of imported goods that sit on the shelves in these stores, the falling Australian Dollar will be a headwind of significant magnitude, as the ability to pass on price rises in this space is limited. In addition, both stores still have a significant portion of floor space dedicated to low-margin electronics and DVDs, both of which are declining in profitability.
Coal mining, chemicals, industrial and safety – Grade: C-
These businesses sit in the Wesfarmers portfolio and act as a drag on the more successful retail operations. These divisions also represent what was the "original" Wesfarmers with a strong focus on resources and associated industries.
Collapsing coal prices, lower resource investment and project deferrals have all impacted these operations negatively. To put it in perspective, the non-mining divisions (Coles, Bunnings etc) earned almost 80% of group revenue in the last year.
With no immediate catalyst in sight for these divisions, and larger, lower cost commodity producers operating around the country, it is difficult to make a strong business case for retaining these assets, beyond the legacy value to the company.
The investors takeaway
The key takeaway is that despite the apparent complexity, Wesfarmers is really a retail play led by Coles, Bunnings and Officeworks. Operating marginal divisions like coal mining has the effect of consuming capital that could be better used on higher margin divisions or to increase payout ratios. Wesfarmers also has a substantial cash pile that many analysts have flagged could be used for a major acquisition in the future.
