When will Wesfarmers exit coal to fund its reinvestment in retail..?
With weak performance from its mining-related operations offsetting decent results from its retail businesses – resulting in flat net profit at half year – there's mounting pressure on Wesfarmers (ASX: WES) to offload its underperforming industrial and coal assets following a sharp downturn in commodity prices.
Directly responsible for wiping out 9.2% earnings growth from the retail operations was an 88% profits plunge from industrials, which included a $118 million loss in coal.
The Industrial and Safety division is suffering along with the mining sector, with earnings falling 28% in the first half.
To put the interim result in context, earnings before interest and tax (EBIT) was in line with forecasts of about $2.16 billion and revenues of $33.5 billion beat estimates after rising 4.7%, but net profits fell short of consensus forecasts of around $1.43 billion.
While margins across the board have come under pressure, other noteworthy results at half year included, 13.4% growth in Bunnings earnings to $701 million, Kmart grew earnings 10.4% to $319 million, with same-store sales surging 9.5% in the December quarter, and Target posted solid gains, with EBIT rising 5.7% to $74 million.
But given the magnitude of the hole within Wesfarmer's half yearly result, it's surprising the share price didn't shed more than around 5% to $41.56.
Managing director Richard Goyder has no immediate plans to sell (coal) assets at the bottom of the cycle, and it's likely that a resetting of the cost base, and an improved exchange rate – and currency hedge position – could potentially improve the future performance of this loss-making division.
Without the hedging losses, management expects the division to break even in the second half.
However, longer term, redeploying cash from coal assets and focusing on long-term growth appears a logical step for the Perth-based conglomerate that's hell bent on improving business performance.
Coal aside, there's renewed focus on improving the Target business which only has an EBIT margin and return on capital (ROC) of just 3.8% and 3.8% respectively.
Much of Wesfarmers focus this year is on merging businesses and cutting costs to reinvest in lower prices and customer service as competition continues to intensify within the $300 billion retail sector.
While the Coles' EBIT growth slowed to 5.6% to $945 million at half year, what was particularly pleasing about the half yearly result was that supermarket operator has now beaten Woolworths on sales growth for 31 consecutive quarters.
Intense competition means that rather than focus on fattening profit margins, the company plans to continue reinvesting cost savings into reducing prices and improving service in stores.
Following on from the consolidation of its chemicals, industrial and safety, and coal operations under one umbrella last year, Wesfarmers plans to combine the Kmart and Target chains under a newly created department store division.
This will ensure that the two brands co-operate for sites rather than compete, as they do now.
The new structure effectively means Wesfarmers' will have eight operating businesses, with each effectively running their own race.
What's also strengthened the market position of Bunnings is the decision by Woolworths Limited (ASX: WOW) to either sell or close Masters Home Improvement stores.
Wesfarmers' now has the opportunity replicate the success of the Bunnings model in the UK where it recently agreed to pay Home Retail Group STG340 million ($A657 million) for the second largest home improvement and garden retailer in the UK and Ireland.
While coal assets and the Industrial and Safety division remain a drogue on Wesfarmers, there's sufficient upside within ongoing restructuring and consolidation; and the UK acquisition to warrant future broker upgrades.
The stock is expected to continue delivering strong earnings per share (EPS) growth, with EPS of $2.15 in 2015 growing to $2.60 in 2018, and is forecast to deliver a dividend yield of around 5%.
Based on a P/E of 19.09, the stock isn't all that cheap. Buy on market corrections with a price under $40 making for a more attractive entry point.