Expectations for a capital return from Wesfarmers Ltd (ASX: WES) is building as the conglomerate announced the sale of its 40% stake in Bengalla for $860 million.
The news isn't doing much to support the stock today though with the Wesfarmers share price slumping 1.9% in late afternoon trade to $31.08 – its lowest level since it spun-off its supermarket division Coles Group Ltd (ASX: COL).
The divestment of the capital hungry Coles had spurred speculation that Wesfarmers will either make an acquisition to fill the earnings hole left by the supermarket chain or undertake a capital return to appease embattled shareholders who have seen the value of their holdings drop 16% since August (adjusted for the divestment).
Growing War Chest
The sale Wesfarmers' stake in the Bengalla coal mine to joint venture partner New Hope Corporation Limited (ASX: NHC) is expected to generate a pre-tax profit of $670 million to $680 million for Wesfarmers when the conglomerate reports its first half profit in February.
That reporting season should see a good number of other ASX companies announce capital returns due to the expected change in the federal government, which will see the removal of franking credit refunds (click here for more on the cash return bonanza).
Unless Wesfarmers can identify a worthwhile acquisition or articulate why it needs to keep excess cash on its balance sheet, the board will be under pressure to undertake an off-market share buyback or pay a special fully franked dividend ahead of the rule change.
Rock and Hard Place
But the decision on capital returns may be harder for Wesfarmers to make than for other ASX companies with a chest full of franking credits and cash to spare.
This is because Wesfarmers is a business that is increasingly exposed to falling house prices. Wesfarmers' owns the largest DIY chain Bunnings as well as a range of other discretionary retail brands like Target and Kmart.
The crash in the Metcash Limited (ASX: MTS) share price is in large part due to worries of a downturn in its hardware division and falling house prices is likely to prompt consumers to cut back on spending.
Management will ideally want to keep a good cash buffer during these uncertain times but justifying the move to grumpy shareholders without issuing some kind of profit warning may be tricky.
Wesfarmers have also stressed that it won't be rushed into making an acquisition. While no one wants to see management make a hasty decision it will regret (like Bunnings UK), board members would be fooling themselves if they thought they could sit on the cash pile for as long as they wanted.
I see value in Wesfarmers shares but that's conditional on the group making the best use of their cash reserves to either buy growth or compensate shareholders for braving the volatile retail environment.
