Wesfarmers Ltd (ASX: WES) is one of Australia's most iconic businesses, owning as it does the Bunnings and Kmart retail chains.
The company also owns a major lithium operation in Western Australia, where it earlier this month announced it would go ahead with a mining expansion project which will double its output.
The quality of the various businesses is not in dispute, but are the shares good value at current levels?
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Wesfarmers shares under the microscope
RBC Capital Markets has just initiated coverage on the company, and this week issued a research report into it.
On the retail front, they like what they see, but say there are some challenges.
As they said:
Bunnings and Kmart are price leaders who can scale into adjacencies with large market opportunities. Bunnings has struggled to return to pre COVID level earnings growth and is seeking new growth avenues through Tools, Automotive, Workwear and Rural. While we believe Bunnings can leverage price trust and convenience (among other advantages) to capture incremental share, specialist operators retain a meaningful edge through range depth, brand relationships, and category expertise.
On Kmart, RBC said its Anko products were reinforcing its value proposition, and its low cost operating model was "further supporting price reinvestment''.
They said digitisation initiatives and the Anko Global in-house product development division "provide a long potential growth runway albeit this is early stage''.
Despite the quality of the company's retail businesses, RBC argues the company looks expensive at current share price levels and has an underperform rating on the stock.
WES owns high quality retail franchises that we believe command premium valuations. However, the current share price implies approximately 25x FY27 EBIT for the retail portfolio, around 23% above the already-premium retail multiple in our SOTP (sum of the parts valuation). This appears demanding because recent earnings upgrades appear to have come predominantly from WesCEF and lithium, for which we do not apply a retail multiple. Our $73.00/share price target therefore reflects full recognition of the strength of Bunnings and Kmart while applying more appropriate valuations to the group's commodity-exposed businesses.
Wesfarmers shares are currently changing hands for $89.42, valuing the company at $102.80 billion.
Lithium not driving the share price
RBC said the WesCEF mining and processing division is as an important contributor to group earnings, but did not alter their view on the company more broadly following Wesfarmers' recent strategy day.
They added:
The division provides diversification and exposure to industrial and energy-related markets, but near-term investor focus is likely to remain on the quality of retail earnings, the Bunnings growth runway and the ability of productivity initiatives to offset cost pressure. Lithium remains strategically interesting, but the earnings contribution is likely to be cyclical and dependent on commodity pricing, ramp-up execution and project economics. In the context of the broader Wesfarmers investment case, we believe WesCEF should be viewed as valuable optionality rather than the primary driver of the share price.
Wesfarmers will announce its full-year results on 27 August.
