The Wesfarmers Ltd (ASX: WES) share price has gone on an impressive run, rising by 15% in the last month.
I'm not expecting the next month (or even the next year) to be as good for Wesfarmers shares, but I do think the owner of Bunnings, Kmart, Officeworks and Priceline has a bright future.
However, the company's price-earnings (P/E) ratio has climbed in the past three years. According to the forecast on Commsec, the Wesfarmers share price is valued at 31x FY25's estimated earnings. Can we justify paying a higher earnings multiple?
The higher P/E ratio doesn't put me off the business. For me, it underlines the quality the market sees in the business.
Let's have a look at those high-quality areas of the business.
Bunnings
In my view, Bunnings is the strongest retail business in Australia. It has an impressive market share in the hardware space with huge scale.
The business has managed to stave off competition, such as the Masters attempt by Woolworths Group Ltd (ASX: WOW). Bunnings is also able to generate a very high return on capital (ROC) of 71.5% (in the FY25 half-year result). This shows the business is generating enormous returns on the money it has put into the Bunnings business.
I think Bunnings still has plenty of earnings growth potential because it's expanding into new product categories (such as pet and auto), growing online sales, and adding more locations to its network.
Bunnings has demonstrated its resilience over the last five years in various economic conditions and has managed to continue growing sales. This is a business worth owning and it's key for Wesfarmers shares.
Kmart
What Wesfarmers has done with Kmart Group over the past several years is extremely impressive. It has managed to improve the product range and quality, while still offering customers great value.
The existing Kmart Group business is an impressive profit-making juggernaut. It achieved a HY25 ROC of 65.9%, which was a year-over-year increase of 7.1 percentage points.
Kmart Group has been working on productivity and efficiency initiatives recently. Growing the store count could also make a noticeable difference in the medium term.
I'm particularly excited by the company's plans to grow its Anko brand in international markets such as Canada.
I think there's significant room for Kmart to continue growing earnings in the longer term and make an even greater contribution to Wesfarmers' shares.
New industries
Where is the next Bunnings or Kmart going to come from for Wesfarmers? Wesfarmers may never be able to achieve the same level of success with another subsidiary as it has with Kmart and Bunnings.
However, I like that Wesfarmers has invested in a number of areas to try to generate additional avenues of meaningful earnings. Success in a sector like healthcare would help send the Wesfarmers share price higher, in my view.
In fairly recent history, it has invested in sectors like healthcare and lithium mining. While neither of those areas has unlocked piles of cash flow for Wesfarmers yet, I like the moves by management to diversify and do something different. The company's overall scale and expertise can give it advantages that other (smaller) competitors don't have.
That willingness to expand into new areas should help the business future-proof itself in the coming years and ensure it stays an attractive long-term idea. I'd still call it a longer-term buy at the current Wesfarmers share price.
