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Wesfarmers – Checkout chit chat

Chief checkout operator Richard Goyder professes to run Wesfarmers as a portfolio of businesses. That implies he is willing to buy businesses he thinks are cheap and that Wesfarmers can add value to while also selling businesses that have benefitted from the process.

Exhibit A is the $19.3 billion acquisition of Coles Group in 2007 that has gradually improved its return on invested capital to the current 10.3%. Coles still has plenty of room to lift its game further to reach world best practice and hence add further value to the business before Wesfarmers declares ‘job done’.

Exhibit B is the sale of the insurance business this year to IAG which enabled Wesfarmers to book a gain on the sale in excess of $1 billion. Nice.

Businesses that remain in the portfolio must therefore be capable of further improvement but this is where the argument gets interesting.

At one end of the scale is the hugely impressive Bunnings home improvement business with a return on capital of 29.3% having just reported operating earnings of $1,082 million in FY14. Its network of 223 Bunnings Warehouses, 64 smaller format stores and 33 Trade Centres across Australia and New Zealand see the $42 billion home improvement market as ripe for further growth.

At $8.5 billion of sales, that implies Bunnings has approximately 20% of the market but with further store growth and expansion into more categories, there is no reason to think Wesfarmers is ready to part ways with this business yet.

The other end of the scale is Target with its 2.9% return on capital a shocking decline from the 11.7% it recorded in FY11. Successive CEOs have struggled to reset Target’s mojo but it’s fair to say a combination of weak markets and poor execution have emaciated the once iconic brand.

Perhaps the most surprising business in the group is Kmart with its 26.9% return on capital almost as good as Bunnings. It has less than half Target’s invested capital (even after Target’s $677 million impairment charge this year) yet produced $366 million EBIT to Target’s $86 million.

Wesfarmers admits its liquor business is sub-standard and has a strategy to repair it through range rationalisation, better cost management and even more stores (it has 831 total along with 91 hotels).

Wesfarmers always includes a nice chart in its presentation that looks back at its acquisition and divestment history to demonstrate its self-proclaimed discipline at managing its portfolio. From 1984 through to the early 2000’s shows a steady but sparsely populated series of acquisitions including Bunnings and Howard Smith. The Coles Group purchase in 2007 dominates the next 15 years but apart from the sale this year of the insurance business, there is little traffic on the exit path.

Is Wesfarmers taking too long to achieve its targets or does each asset have such peculiar aspects that there can be no such metric as average holding period and return on investment?

It all seems a little too random.

With net debt of just $3.4 billion (gearing 13%), the market is holding its breath to see what Wesfarmers might have a crack at buying.

With private equity firms in a huge rush to sell assets or float them, perhaps the time is not right to be acquiring assets. Hence, Wesfarmers has at least embarked on a beefy strategy of paying fatter dividends and lobbing in capital returns as well to help out shareholders. Bravo.

Holders of this stock should feel reasonably well rewarded but it’s hard to recommend chasing this one at current levels.

Should you own Woolworths instead?

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