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Why brokers are nervous on Wesfarmers Ltd shares after Homebase sale 

Bunnings

Shares in listed conglomerate Wesfarmers Ltd (ASX: WES) pared back gains Monday after news that it was selling its long suffering UK home improvement business saw the shares climb to an 18 month high last Friday. 

The stock has been a solid performer over the past few weeks but is still looking relatively compelling to peers on a relative basis despite its share price strength.  

On a one-year basis, the stock has gained 5.9% compared to an 11.1% gain for Woolworths Group Ltd (ASX: WOW) and a whopping 50.5% gain for Metcash Limited (ASX: WOW).

On a price-to-earnings (P/E) basis, the stock is also not looking too pricey, trading on a P/E of 16.1 times, compared to 22.5 times and 18.9 times for Metcash and Woolworths, respectively, according to Reuters estimates. 

But is this enough to say that the stock is worth another look right now? 

For many brokers, the answer is no, with most cautious on the stock despite welcoming the sale of the UK home improvement business, Homebase, as a good move. 

Broker UBS kept its “Neutral” rating on the stock, saying it believes Wesfarmers is fair value at current levels. 

“We believe WES has a strong suite of businesses, with market-leading positions; however, the short/medium-term earnings outlook remains relatively muted,” the broker said in a report.  

“That said, at c18x FY19e EPS, and a c5% FY19e dividend yield, we retain our Neutral seeing few immediate catalysts for underperformance. Key positive catalysts on a 6-12mth view are likely: i) Positive margin surprise at Coles if real LFL trends improve; and, ii) Capital return funded via Curragh proceeds, which we view as likely at the FY18 result.” 

Shaw and Partners also kept its “Hold” rating on Wesfarmers, mainly due to valuation concerns following the stock’s strong run.   

“The stock has run strongly recently, and with our TSR at 1.2% it is getting toppy as the valuation also gets stretched,” it said in a report. 

Ord Minnett was also cautious, retaining its “Hold” rating, saying the outlook for Wesfarmers is somewhat mixed and it sees a lack of valuation support.  

“The new CEO and CFO are driving bold change, addressing challenged divisions and share price underperformance. Bunnings is expected to continue to perform very well following industry consolidation and its strong position in ANZ, with the BUKI exit judicious. Coles, under new leadership, could leverage the undemanding comparable numbers and margins to drive performance, although Woolworths (WOW, Accumulate) has momentum with the demerger business cum capex,” it said.

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Motley Fool contributor Gabriella Hold has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Wesfarmers Limited. 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 Scott Phillips.

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