The Wesfarmers Ltd (ASX: WES) share price has been a very impressive performer this year, rising by 26%, as the chart below shows.
The owner of Kmart, Bunnings, Officeworks has been an excellent investment. But, the question now is whether the business is still attractive or not.
The higher a share price goes in a short amount of time, the more that valuation can be a risk itself. So, let's take a look at the pros and cons of investing in it.
Pros of buying Wesfarmers shares
In my view, the business is one of the best retailers in Australia. Kmart, Bunnings and probably Officeworks are what I'd call category leaders across general merchandise, hardware and office products.
Being the biggest in each of those categories allows the business to earn strong margins and still provide customers with great value. The company's margins have been increasing over the long-term and analysts are expecting profit margins to steadily increase between FY25 to FY29.
UBS is forecasting the operating profit (EBIT) margin for the business could reach 9.1% in FY25, 9.5% in FY26, 10% in FY27, 10.3% in FY28 and 10.5% in FY29. The return on equity (ROE) is also very high – in the FY25 first-half result, it reported a ROE of 31.2%. It's these sorts of statistics that make me believe the business is worthy of a higher price/earnings (P/E) ratio than it was before FY25.
Wesfarmers can open a new Bunnings or Kmart store, and it can provide a very useful boost to overall profitability because that new revenue adds to earnings at a high profit margin.
The company is building new growth avenues for its two leading businesses. Within Kmart Group, it has launched Anko stores in the Philippines, which I think could be a great source of growth due to it being a new market with a very large population. It has also started sell some Anko products to retailers in North America.
As a general point, I like that Wesfarmers is able to change its portfolio and invest in new areas of opportunity such as healthcare and lithium mining.
Ultimately, I like how the business is growing profit in a variety of ways and is projected to see ongoing growth for the foreseeable future. UBS is forecasting that Wesfarmers' net profit could rise from $2.64 billion in FY25 to $3.8 billion in FY29.
Negatives
Wesfarmers doesn't have many negatives, in my view, thanks to its diversification strategy.
But, the rapid rise of the Wesfarmers share price has meant that it's now trading on a high P/E ratio.
According to the forecasts from UBS, it's valued at 39x FY25's estimated earnings.
This has also pushed down the dividend yield, so it's not as attractive as it was for passive income. UBS' projection that the FY25 dividend per share could be $2.11 means it could have a grossed-up dividend yield of 3.3%, including franking credits, for FY25.
Final thoughts on the Wesfarmers share price
Ultimately, I don't think this is going to be the highest point of the Wesfarmers share price – I believe it will continue rising in the long-term as net profit grows.
However, due to the higher P/E ratio, I'm less confident Wesfarmers shares are going to deliver a double-digit return over the next 12 months than I was at the start of the year.
