Wesfarmers Ltd (ASX: WES) shares have done well for shareholders, rising by 17% this year. I'd put the business as one of the best ASX dividend shares on the ASX.
It's the business behind names like Bunnings, Kmart, Target, Officeworks, Priceline and Catch. There are also industrial, chemical, energy and fertiliser businesses within the Wesfarmers umbrella.
There are three key reasons why I think it's a great business for passive income.
High-quality
No dividends are guaranteed, but I think some businesses are more at risk of large dividend cuts than others. I think Wesfarmers shares tick several quality metrics.
The business has market leaders within its ranks of Bunnings, Kmart and Officeworks.
It has managed to deliver earnings growth despite difficult trading conditions. Overall FY23 net profit after tax (NPAT) increased 4.8% to $2.46 billion.
In the six months to June 2023, Bunnings earnings rose 0.7% to $952 million, Kmart Group earnings increased 3.9% to $294 million and Wesfarmers chemicals, energy and fertilisers (WesCEF) earnings grew 7.1% to $345 million. Total divisional earnings grew 5.6% for the six months to June 2023 to $1.7 billion.
In FY23, Wesfarmers delivered free cash flow of $3.6 billion. That's a lot of usable money for the business to make acquisitions and pay passive dividend income.
For me, the most impressive thing in FY23 was that it achieved a return on equity (ROE) of 31.4%. That means it made a return/profit of just over 31% of the retained shareholder money within the business.
Dividend growth of Wesfarmers shares
Wesfarmers has been a somewhat different business since FY19 after it divested most of its stake in Coles Group Ltd (ASX: COL).
The ASX dividend share grew its dividend in FY21, FY22 and FY23, despite the volatility caused by COVID-19.
I think it's quite important for a business known for its dividends to increase the shareholder payout in most years. That's to ensure that inflation isn't eating into the value of those dividends too much and that there is a high chance the dividends will keep coming even if there's a downturn. I think dividend strength can be supportive for the Wesfarmers share price as well.
On Wesfarmers' website, it explains how it wants to deliver long-term shareholder returns:
With a focus on generating cash flows and maintaining balance sheet strength, the group aims to deliver satisfactory returns to shareholders through improving returns on invested capital. As well as share price appreciation, Wesfarmers seeks to grow dividends over time commensurate with performance in earnings and cash flow.
In summary, the company has publicly stated the importance of paying dividends and hopefully growing them.
Healthy payout ratio of Wesfarmers shares
For me, one of the most important factors for ensuring long-term growth is a dividend payout ratio that isn't sitting at 100%, or close to it. If profit were to fall, the dividend payout ratio would need to go above 100% to maintain the same annual dividend per share.
A lower dividend payout ratio gives the business more wriggle room to maintain and grow the dividend. A lower payout ratio also means that there's more retained profit to re-invest for long-term growth and unlock the ability to pay bigger dividends in future years.
In FY23, it had a dividend payout ratio of 87.7%. That's rewarding for shareholders and leaves a bit for re-investing.
Foolish takeaway
At the current Wesfarmers share price, it could pay a grossed-up dividend yield of 5.2% in FY24 and 5.9% in FY25, according to Commsec, thanks to projected profit growth in the next two financial years.
