Is this a reason to sell your Wesfarmers Ltd shares?

Credit: Target

What: The share price of Wesfarmers Ltd (ASX: WES) has fallen close to 4% in the past five trading session. In contrast, the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) is down just under 2%.

So What: One explanation for the cause of the underperformance could be a story run in the Australian Financial Review’s (AFR) Chanticleer column on March 30 titled: “Wesfarmers investigates how Target used suppliers to boost profit.”

The crux of the report points to an alleged cash rebate from suppliers to the Wesfarmers owned Target department store business which had the supposed effect of boosting profits in the first half ending December 31.

Now What: While the AFR has reported some details surrounding the allegations, there has been no official release from Wesfarmers regarding this issue.

Based on the limited information available, it appears Target was aggressive in the accounting policy used to report its interim results. However this could also reasonably be expected to unwind come the full year results.

The fact that this has been picked up so early after the event – an internal investigation involving its auditors is currently believed to be underway – suggests Wesfarmers’ management is on top of the issue.

Likewise, the size of the reported boost to profits is certainly of minor relevance at the group level and doesn’t change the fact that Target remains a gross underperformer.

With the stock trading roughly in line with its average price-to-earnings multiple over the past seven years, the stock would appear to be fairly valued.

Rather than viewing this news as a risk and hence reason to sell, the greater risks would appear to be skewed to the upside. The possibility of a turnaround in Target’s performance and the pending expansion of Bunnings into the UK could both provide meaningful avenues for earnings growth in the future.

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Motley Fool contributor Tim McArthur has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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