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Is the Wesfarmers share price the best buy for dividends?

Bunnings
Photo credit: AS 1979

Is the Wesfarmers Ltd (ASX: WES) share price the best buy on the ASX for dividends?

The old conglomerate has been a solid option for dividends since the GFC with solid growth, particularly thanks to Bunnings.

How are the Wesfarmers operations going?

We’ll soon found out about the HY20 result, but in FY19 Bunnings generated earnings before interest and tax (EBIT) growth of 8.1% to $1.6 billion with a trading EBIT margin of 11.7%, Bunnings’ EBIT was more than half of Wesfarmers’ continuing EBIT in FY19.

In FY09 Bunnings generated EBIT of $659 million at a trading EBIT margin of 11.2% and was the third largest division in EBIT terms.

Bunnings has done very well over the past decade. It’s grown into one of Australia’s biggest, and best, retail businesses whilst seeing off the threat of Woolworths Group Ltd’s (ASX: WOW) Masters.

The Wesfarmers Industrials segment remains reliable but it isn’t flying, in FY19 the division grew EBIT by 4.4% to $519 million.

Kmart Group (Target and Kmart) saw EBIT fall by 13.7% to $540 million and Officeworks grew EBIT by 7.1% to $167 million.

It also continues to own large stakes of Coles Group Limited (ASX: COL) and BWP Trust (ASX: BWP) which are providing attractive income for Wesfarmers.

I’ve been impressed by Wesfarmers’ recent acquisitions to try to generate growth such as Catch Group and the acquisition of Kidman Resources. The Catch Group buy has increased the e-Commerce capabilities of Kmart Group, which is needed to future-proof the retail division and hopefully create growth.

What about the dividend?

It’s quite unlikely that we’ll see a special dividend this year. I think Wesfarmers would be much better retaining earnings so that it can re-invest into its current operations or acquire other businesses.

One projection for the FY20 Wesfarmers dividend puts it at $1.44 per share, which would equate to a grossed-up yield of 4.5% at today’s elevated share price. The dividend is projected to grow in FY21 and again in FY22.

But you shouldn’t buy a business just because of a dividend. The valuation needs to make sense too. Wesfarmers is now trading at 27x FY20’s estimated earnings.

I’d prefer to own Wesfarmers than the big banks over the long-term because of its earnings diversification and ability to diversify further, but it looks too expensive to me unless Bunnings can keep growing EBIT strongly to justify today’s high price.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of 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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