Wesfarmers (ASX WES) announced third quarter comparable sales numbers and it shows why it is eating Woolworths (ASX WOW) lunch. It is no secret that Woolworth is undergoing through a number challenges from closing down the Masters business to a new CEO under pressure to turn the business around.
Wesfarmers is a conglomerate that owns multiple businesses from insurance to coal mining and retailing from staples to discretionary such as Target and Kmart. Coles is its largest division and the jewel in the Crown. Looking back, it made a great buy just before the GFC and the management execution of a turnaround has been very impressive.
The conglomerate structure kept us on the sidelines of the ASX WES stock. We like pure play sector exposure. If we want insurance, we want the best listed insurer, if we want coal miner we like the lowest cost producer. A conglomerate reduces the ability of the investors picking the best of the best.
Wesfarmers however has 2 best retail business in Australia. Coles and Bunnings.
Chart above shows the same store sales growth of Coles and Liqueur division in Wesfarmers over the last year. Results show a steady growth in food sales above inflation with high single digit liqueur sales growth.
This is contrast to Woolworths which is going backwards in comparable sales in food. Needless to say, food sales is a key trigger for Woolies. We think the sub par performance is due to it being noticeably more expensive than Coles. As a result, consumers are voting with their wallet and shopping at Coles. The weaker numbers coming out of Woolworths reflect this.
ASX WES Shares
Chart above shows the return of WES vs WOW since the beginning of the year.
We made a mistake of picking Woolworths over Wesfarmers shares in our core portfolio. WOW has significantly unperformed WES share price. It just shows only because a stock is expensive does not mean it is not a good buy.
Another key trigger for the WES share price is its exposure to Bunnings. Following the close down of Masters business, Bunnings has maintained its industry leading position in Hardware retailing. The ability of this business to continue to grow market share and same store sales is very impressive. This only factor holding it back in our view going forward is the potential cyclical nature of the business.
Our view is that Australian property is reaching a cyclical high and prices will struggle going forward. Bunnings is the primary beneficiary of a strong residential construction market. Any slowdown would be negatively impact Bunnings.
WES announced impairment charges it is expected to take in the 2016 full year results. Whilst these impairments are on segments of WES ASX which were struggling to begin with and not a complete surprise, it is a factor of investing that sometimes the negative comes with positives.
The company in a conglomerate structure has a diverse set of businesses which diversifies the risks during periods where parts of the business is clearly struggling. The downside for shareholders is that during good periods, unless the positives is eroded within the broader business unless it is truly meaningful i.e Coles.
- $1.1b to $1.3b impairment relating to Target
- $600m to $850m to Curragh, the asset in the coal mining business.
One note we would like to highlight in regards to the write off is the management comment in the ASX release that these impairments are “non-cash”. In our experience funny we never see a cash impairment. Accounting 101 present the fact that asset appears on balance is result of change in cash or in event of takeover, a equity consideration in the merged company.
If an asset that is generating income that is below initial expectations, it would mean that its value on the balance sheet is impaired. If the value is material to the company then an announcement on the ASX is made.
The management always try to fluff it up as being non cash to play down the significance of the event. However for an asset to get on the balance sheet as an asset means sometime in the past company paid for it with cash or equity. Hence a write off today means that previous price paid for said asset was higher what it is worth today.
Now there is no doubt in our mind that the Coles acquisition is value accretive for current ASX Wesfarmers shareholders but above is a good explanation on what is the cause and consequence of asset impairments.
We will be keeping an eye on this position going forward.
Wesfarmers Dividend Dates 2017
Interim Ex-Dividend Date: 20/2/2017
Interim Record Date: 21/2/2017
Interim Dividend Payment Date: 28/3/2017