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Is this the next blue-chip to issue a profit warning?

The confession season is adding to the uncertainty afflicting our market. While the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is trading higher today, the next sell-off could be only a Trump Tweet or profit warning away.

No one can predict what Trump will do next – not even Trump I suspect – but we can make a guess where the next profit warning could come from.

Investors have already been stung with disappointing earnings news from the likes of Reliance Worldwide Corporation Ltd (ASX: RWC), Flight Centre Travel Group Ltd (ASX: FLT) and Viva Energy Group Ltd (ASX: VEA).

The next profit warning candidate

The next that could issue a profit warning is Wesfarmers Ltd (ASX: WES) after Morgan Stanley said the readthrough from DuluxGroup Limited (ASX: DLX) first half result that was released yesterday painted a gloomy picture for Bunnings.

Home improvement chain Bunnings is a major earnings driver for Wesfamers after it spun-off the Coles Group Ltd (ASX: COL).

“Dulux’s 1H19 results point to a slowing in the decorative paints market, so we see greater risk to our Bunnings 2H19 (and beyond) LFL [life-for-like] sales forecasts,” said Morgan Stanley.

“We argue the implied Bunnings P/E [price-earnings] of 25x is too rich given exposure to the deteriorating housing cycle.”

Dulux paints gloomy picture for Wesfarmers

The broker estimate that Dulux generates around a quarter of its sales to Bunnings and the paint brand represents about 5% of Bunnings sales. Paint is one of the top selling categories at the retail chain.

First quarter sales for Dulux fell 5% but rebounded to grow at 6% in the second quarter. But don’t hope that this jump can be sustained as Morgan Stanley believes the sharp rebound is due to one-off factors.

“During the half DLX indicated that the decorative paint market (volume) declined by 4%, which leads us to think that weaker housing activity and house prices are drivers of the category,” said the broker.

“We now see downside to our 2H19 Bunnings LFL sales growth forecast of +2.4% (vs 1H19 +4%) and believe as LFL sales growth slows the WES P/E multiple will compress.”

Morgan Stanley has an “underweight” recommendation on Wesfarmers with a price target of $29 per share.

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Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Reliance Worldwide Limited. The Motley Fool Australia owns shares of and has recommended COLESGROUP DEF SET, Flight Centre Travel Group Limited, and Wesfarmers Limited. The Motley Fool Australia has recommended Reliance Worldwide 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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