Why did Goldman Sachs just downgrade Wesfarmers shares?

The ASX 200 conglomerate has had a ripper run of share price growth. So why is Goldman Sachs downgrading it?

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Wesfarmers Ltd (ASX: WES) shares are 3.6% lower on Friday at $63.92 apiece in early afternoon trading.

There is no news out of the conglomerate today, so the stock is likely just moving with the market.

At the time of writing, the S&P/ASX 200 Consumer Discretionary Index (ASX: XDJ) is the weakest of the 11 market sectors, down 2.19%.

Wesfarmers is the largest ASX discretionary stock by market capitalisation.

The benchmark S&P/ASX 200 Index (ASX: XJO) is also 1.14% lower today.

What's been happening with the Wesfarmers share price?

Wesfarmers shares have had a great run over the past 12 months, clocking an impressive 28.6% growth. This compares to a 13.3% lift for the consumer discretionary index.

In the year to date, Wesfarmers shares have moved 10.9% higher while the index has lifted 4%.

On 8 May, Wesfarmers shares hit an all-time high price of $71.11.

So why is top broker Goldman Sachs downgrading this clear sector outperformer?

Why did this top broker just downgrade Wesfarmers shares?

Goldman Sachs recently released a new report on ASX retail shares, with analysts Lisa Deng and James Leigh re-jigging their stock picks in the sector.

There are 6 ASX retail shares they rate as a buy and 3 retail shares they recommend selling.

However, one that sits in the middle with a neutral rating is Wesfarmers shares. This represents a downgrade for the high-flying stock as it was previously rated a buy.

Buy thesis on Wesfarmers shares has 'played out'

Goldman did not change its 12-month share price target on Wesfarmers in its recent review. Nor did it change its earnings expectations.

It still likes the stock but explains that its buy thesis has now simply "played out".

Goldman put Wesfarmers on its buy list on 25 January and further increased its target price ahead of the company's Strategy Day on 9 April.

This was all premised on Bunnings' better-than-expected performance, the expectation that Bunnings and Kmart would generate high free cash flow for investment into Wesfarmers' high growth and high-returning businesses in lithium and health, and some upside valuation potential for its health business.

Deng and Leigh said:

… our Buy thesis of resilient Retail (Bunning and Kmart) businesses generating ~A$2.0-A$2.5B free cashflow to invest behind growth opportunities (Digital and Health) is now fully factored in.

Post the 1H23 results and 2023 Strategy day, the above thesis has largely played out …

Our EBIT/EPS is now not differentiated vs Factset consensus in FY24 though remains ~5% above Consensus in FY25/26e, largely due to Bunnings margin expansion.

The analysts also commented that they have a more favourable view of consumer staples shares over consumer discretionary shares at the moment.

Deng and Leigh said they "see better value in staples where valuation and earnings expectations are less demanding".

They think consumers are "clearly increasingly value-focused" amid anticipated delays in interest rate cuts, with Goldman recently changing its predicted timing for the first cut from August to November.

The March retail figures from the Australian Bureau of Statistics (ABS) showed the weakest annual rise in retail spending on record outside the pandemic and the introduction of the GST.

Not much room left for more share price growth

Goldman has a 12-month price target of $68.80 on Wesfarmers shares.

So, there's not much upside available for investors who buy the stock at today's price — just 7.6%.

Motley Fool contributor Bronwyn Allen has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Goldman Sachs Group and Wesfarmers. The Motley Fool Australia has positions in and has recommended Wesfarmers. 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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