Shares in Wesfarmers Ltd (ASX: WES) have fallen by 2% in the last year as investors have become rather concerned regarding the future of its supermarket operations. While Wesfarmers is a conglomerate with a range of products from chemicals to fertilisers being produced and sold, its retail operations accounted for over 90% of operating profit in its most recent financial year.
This could cause Wesfarmers a major problem moving forward, since supermarkets and department stores such as Wesfarmers-owned Coles and Kmart are forecast to endure a challenging period.
The reason for this is simple: the Australian economy is going through a tough time with commodity prices coming under pressure, unemployment being relatively high and China's growth rate slowing down.
The impact of this could be a reduction in the disposable incomes of shoppers who may seek out more inexpensive options as they become increasingly price conscious. This is a key reason why no-frills operators such as Aldi and Costco have been able to expand their operations within the grocery space.
Over the medium to long term, it appears as though Wesfarmers and its peers may need to engage in further investment in pricing (in other words, discounting) so as to remain competitive. The impact of this on margins is unlikely to be positive, although it may help to shore up sales and market share. This has been the situation in the UK in recent years, with major supermarkets seeing their profitability fall considerably as a price war has dominated the supermarket scene.
Despite this, Wesfarmers could still prove to be a sound long term investment. For starters, the fall in interest rates is likely to have a positive impact on consumer spending levels, since it will mean the cost of credit falls and it could allow Wesfarmers' sales figures to surprise on the upside. That said, Wesfarmers is already expected to increase its earnings over the next two years, with its bottom line forecast to rise at an annualised rate of 6.8%.
This should mean that Wesfarmers' dividends are highly sustainable – especially since they are presently covered 1.2 times by profit. As such, the company's yield of 5% remains appealing and, with Wesfarmers having a beta of 0.64, it continues to be a low-volatility stock which could provide stability to portfolios in the short term. And, with a price to sales (P/S) ratio of just 0.74 versus 1.36 for the ASX, it appears as though the challenges Wesfarmers is facing are already priced in via a relatively wide margin of safety.
As a result, and while its shares may come under pressure in the short run if the economic outlook deteriorates, Wesfarmers remains a top notch long term buy.
