Wesfarmers facing retail challenge

There is not a crisis at Wesfarmers, that’s the good news, but there’s certainly a problem – and it’s starting to worry investors.

In simple terms, the biggest business headquartered in Perth appears to have slipped into a low-growth, or even a no-growth phase, a shift that has wiped more than $6 billion off the company’s stock market value.

Last week’s release of September quarter sales revealed the challenge of Wesfarmers’ heavy reliance on its retail divisions, especially the food and liquor division of Coles, which is under attack from several directions.

Always a fine-margin business, food and liquor is being squeezed by growing competition from Germany’s Aldi and other new entrants into the Australian market, and by a resurgent Woolworths, which is shaking off its problems.

The net result is that the total sales figure for Coles, which includes good, liquor and convenience, slipped by 0.3 per cent to $9.4 billion in the September quarter, the weakest like-for-like sales in shops run by Coles since 2009.

Within minutes of the sales numbers being released last Wednesday, the Wesfarmers share price took a dive, falling from $43.90 to a low of $40.02 on Friday, before edging up a few cents.

To see the full extent of the share price slide, however, it’s necessary to go back two weeks to October 14, when Wesfarmers was trading at a 12-month share price high of $46.06; its latest price of $40.32 represents a fall of $5.74, which translates into a fall in market value of $6.5 billion.

Share prices rise and fall every day and what’s just happened to Wesfarmers is nothing new, but the stock market reaction to the retail sales data is a sign that investors believe the company’s strong recovery from the 2008 financial crisis has ended.

It’s what comes next that concerns investors, who have grown accustomed to Wesfarmers delivering strong profit growth, followed by generous dividends.

The outlook is mixed – dividends are likely to remain generous but profits are unlikely to grow as quickly as they have during the past eight years.

At its heart, Wesfarmers is very much a retail-focused business with its Coles, Bunnings, Kmart, Target and Officeworks brands delivering the lion’s share of sales; its industrial division, which includes two improving coal mines, provides the balance expected of a diversified asset portfolio.

The challenge in assessing Wesfarmers is to discount the non-retailing operations, because they are small beer in the overall business, and can sometimes become more of a distraction for management than an asset.

Focusing on its core retailing operations has become more important for Wesfarmers than at any time since it acquired Coles and grew Bunnings into Australia’s dominant hardware chain; because if it doesn’t fight back against Aldi and Woolworths, it risks going into decline – just as Woolworths did when it misread the Coles revival.

The speed at which Wesfarmers has gone from a company that could do no wrong to one that is being questioned can be seen in the latest batch of investment bank reports, with none better than those on successive days from Morgan Stanley.

Last Tuesday, the day before Wesfarmers released its September quarter sales result, Morgan Stanley noted that Coles was ‘cooling’, the Target department store was ‘re-basing’ and Wesfarmers’ shares were a hold (or equal-weight on Morgan Stanley’s system) with a price target of $43.

The following day, after the surprisingly weak sales results were released, Morgan Stanley did a double take, noting that it was ‘Coles’ turn for a margin unwind’ (a comment on what had previously happened to Woolworths) and the price target dropped to $41, while the ‘hold’ tip was maintained.

Share market moves are not everything in assessing a company, but they do provide a guide, and right now the view of investment bank analysts is that Wesfarmers is possibly fighting battles on too many fronts – a strategic mistake sometimes made in military campaigns.

The recent sharp rise in the price of coal has taken the pressure off Wesfarmers’ mining interests, but the entry of Aldi and the return of Woolworths are pressuring food and liquor retailing.

Bunnings, which is basking in the limelight of driving its Masters competitor out of business, should be a star for the next few years, unless management is distracted by the adventure in British hardware retailing.

It’s the mixed outlook that caused Deutsche Bank to downgrade its view of Wesfarmers, slashing its share-price target from $43 to $38 and swapping its ‘hold’ tip to ‘sell’.

The gloomy Deutsche Bank view sits starkly alongside that of Goldman Sachs, which reckons Wesfarmers will put a shaky start to the current financial year behind it with the share price expected to recover to $48.50.

The $10.50 a share gap between the Deutsche and Goldman Sachs valuation is a measure of the uncertain outlook for Wesfarmers – and retailing in general.