The Wesfarmers Ltd (ASX: WES) share price will be on watch on Tuesday after being the subject of a broker note out of Goldman Sachs this morning.
According to the note, the broker has downgraded Wesfarmers' shares to a neutral rating from buy and cut the price target on them from $34.50 down to $32.50.
Why has Goldman Sachs downgraded Wesfarmers' shares?
Goldman made the move after turning more cautious on the outlook for the Bunnings business due to numerous factors.
These include short term weather, cyclical trends in the housing sector continuing to soften, and concerns that the capacity for large format home improvement stores in Australia could saturate in the short to medium term.
In respect to weather, the broker notes that on average the weather has adversely impacted trading conditions for Bunnings during the December half.
And as temperature can also be a factor and extremes can slow outdoor activity, recent heatwaves are unlikely to have helped since the turn of the year.
Another concern for Goldman is the fact that macro housing trends have continued to deteriorate. The broker points out that PCI data for December showed a notable decline in activity across both sales and new orders in December. PCI data is a leading indicator for building approvals.
Goldman believes this is a warning sign for the home improvement market. Its analysts said: "When combined with industry feedback across channels, we believe the macroeconomic environment in home improvement is deteriorating more rapidly than we anticipated."
A final concern Goldman Sachs has is the capacity of the home improvement market.
Wesfarmers has advised of plans to increase its Bunnings store network by net 10-14 stores per annum, but the broker isn't convinced this will be possible.
In fact, the broker believes that the saturation point may already have been achieved for large format stores. This is based on comparisons with the U.S. market and the population catered to per square metre of large format home improvement stores.
The U.S. market has 8.4 persons per square metre of large format home improvement stores and is believed to have reached saturation point. Whereas Australia currently has 8.1 persons per square metre, indicating limited capacity growth if the U.S. market is a guide.
What now?
I think Goldman makes some great points and given the importance of the Bunnings business to Wesfarmers' overall results since the demerger of the Coles Group Ltd (ASX: COL) business, I can understand why this would be worrying its analysts.
However, with its shares changing hands at 19x estimated forward earnings and below Goldman's price target, I would still be a buyer of its shares at these levels ahead of Woolworths Group Ltd (ASX: WOW).
