Broker claims Wesfarmers Ltd is a share to avoid in housing downturn

The softening in house prices even as global economic growth picks up pace has only reaffirmed the belief that shares are likely to outperform property in the new financial year.

However, not all stocks are well placed to run ahead when the housing market is weak, and the Australian Financial Review has reported that Citigroup has created a shortlist of stocks to avoid in this environment.

The downturn in the housing market, which is confirmed by the latest batch of housing data, is unlikely to turnaround quickly either. Cycles in this market tend to take months if not years to play out and I can’t see how home prices can rebound in the near or medium-term.

Besides the obvious casualties in the home building sector, Citi has put conglomerate Wesfarmers Ltd (ASX: WES) and electrical and furniture retailer Harvey Norman Holdings Limited (ASX: HVN) at the top of its shortlist of stocks to avoid.

This is because 40% of Wesfarmers earnings before interest and tax (EBIT) comes from its hardware division Bunnings (and the percentage is likely to increase once Wesfarmers divests Coles), while 39% of Harvey Norman’s EBIT comes from furniture and appliances.

There is of course a counterargument regarding Bunnings. Some believe that an easing property market (and no one is predicting a hard landing at this point) will prompt homeowners to renovate instead of sell their properties, and that should give some protection to Wesfarmers.

On the other hand, the consensus view is that furniture and appliances sales tend to be more correlated to new household formation – that’s unless you ask Gerry Harvey, the chairman of Harvey Norman.

He has lambasted this conclusion in the AFR saying there’s “not a lot of validity” to Citigroup’s findings, even though the broker has found that a 1% move in home prices has led to a 4% change in Harvey Norman’s sales and earnings.

Mr Harvey’s argument is that population growth and rapidly changing technology are more important drivers for his company’s growth, but that’s assuming a very mild downturn in home prices and I think the fact that we are seeing an acceleration in the decline in home prices in the latest data means we’re past the point of “very mild”.

Citigroup thinks the bad news is not yet fully priced into Harvey Norman’s share price either even as it suffered a 20% plus crash since the end of February.

In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) is down 1% over the same period while Wesfarmers is 11% in the black.

But it isn’t only these two stocks in the firing line of a retreating housing market. The broker also thinks hardware and grocery group Metcash Limited (ASX: MTS) and electronics and whitegoods chain JB Hi-Fi Limited (ASX: JBH) are in for a rough time.

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Motley Fool contributor Brendon Lau 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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