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Why Wesfarmers Ltd (ASX:WES) and Woolworths Group Ltd (ASX:WOW) will be in focus this week

Investor attention is likely to turn to Wesfarmers Ltd (ASX: WES) as the conglomerate is expected to release details on the $20 billion demerger of its Coles supermarket business.

There’s speculation that Wesfarmers will be letting fund managers look under the hood of Coles before the supermarket releases its quarterly sales announcement on October 15, according to the Australian Financial Review.

Coincidentally, the AFR also reported that archrival Woolworths Group Ltd (ASX: WOW) is looking for a retail broker to help with the initial public offer (IPO) of its petrol station and convenience retail business that is tipped to be worth around $2 billion.

The difference between the two divestments is that Coles is likely to be an in-specie distribution where existing shareholders in Wesfarmers will be entitled to shares in Coles based on the number of shares of Wesfarmers they hold.

Woolworths will be a typical IPO where investors will need to apply (and pay) for shares in the petrol business.

The share price of Wesfarmers has jumped 12% since it announced the demerger in March this year while Woolworths has gained less than 5%, which is just ahead of the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index over the period.

I’m not suggesting that Wesfarmers’ outperformance is based only on the spin-off of Coles, but history has shown that in-specie separation of assets is often positive for shareholders over the medium-term while the jury is out on IPO-style divestments.

There’s also worries that the re-rating of Wesfarmers may not last. Investors are happy to pay a higher premium for Wesfarmers on the premise that it cuts Coles’ apron strings (conglomerates typically trade at a discount to more focused businesses) but some brokers like UBS don’t think this will last.

It’s understood that Coles will be straddled with around $2 billion in debt when it lists and will have a fairly heavy capital expenditure requirement to combat Woolies and the discount grocers like Aldi.

The tailwind from its Little Shop promotion is also waning and there are worries that Coles will trigger a new price war as it looks to assert itself as the new kid on the block.

At the same time, UBS is worried that the businesses left with the mothership, including Bunnings and department stores Kmart and Target, are increasingly exposed to fickle consumer spending at a time when property prices and household debt are going in the wrong direction.

Interestingly, history has also shown that the parent stock tends to underperform going into the demerger (in Wesfarmers case, it’s November) and that the child entity outperforms after the first few months as a listed company.

This means investors may be better off selling Wesfarmers now and buying Coles on-market when it lists, although trying to time your entry and exit into stocks is a very tricky thing to get right.

This makes what Wesfarmers says when it releases details of Coles all that more important.

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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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