The ASX200’s eighth biggest company and best known conglomerate reports earnings on Thursday. Here's what our analysts are looking out for, and our long-term view on Wesfarmers (ASX: WES) shares.

Which Wesfarmers segments are most important?

Wesfarmers' diversified portfolio provides exposure to many segments of the Australian economy. Even after the divestment of Coles, most of the conglomerate’s earnings are consumer related.

Here is a rough breakdown of where the company's pre-tax earnings are generated:

  • Around two-thirds of the company’s earnings come from its Bunnings chain of home improvement stores

  • The Kmart Group, which includes the Kmart and Target department store businesses, accounts for around 15%

  • Another 15% come from various industrial businesses across chemicals, energy, and fertilisers

  • The remaining 5% or so comes from other businesses including Officeworks

Does Wesfarmers have a moat?

Wesfarmers’ collection of household name subsidiaries (past and present) make it Australia’s best known conglomerate. It is also a high quality business according our analysts, who have assigned it a Wide Moat rating. This means they think Wesfarmers enjoys structural advantages allowing it to generate excess returns on capital for at least twenty years.

The company's Wide Moat rating stems mostly from advantages in the Bunnings business.

Bunnings dominates Australia’s home improvement retail sector with a market share of close to 25%. The company’s scale gives them significantly more bargaining power with suppliers and landlords than smaller competitors. And Morningstar’s Johannes Faul says Bunnings have passed most of these savings through to shoppers and built a loyal customer base in doing so.

Bunnings also benefits from its network of entrenched and far-flung stores in high-traffic corridors across Australia. This increases convenience for its customers and also goes some way to insulating Bunnings from online competition in the near future.

Elsewhere in the conglomerate, Faul thinks that Officeworks – which delivers around 5% of group earnings – would also command a Narrow Moat rating if it were a stand-alone business. Like Bunnings, Officeworks enjoys scale-based cost advantages from being the dominant player in its niche. It has also adapted well to changing shopping trends and has built a strong omnichannel offering, including online. 

By contrast, Faul does not think that Wesfarmers’ industrial or department store segments have an economic moat. In the case of Kmart and Target, the combined operation enjoys some scale benefits. But this is outweighed by it selling commoditised products in a category that has proven more prone to disruption by e-commerce players like Amazon.

What are Morningstar looking out for in Wesfarmers earnings?

Ahead of earnings, our Wesfarmers analyst Johannes Faul pointed to three things he’ll be keeping an especially keen eye on.

Lithium losses

In 2021 Wesfarmers’ announced a major investment in lithium through a joint venture with major Chilean mining firm Quimica. The Mt Holland project in Western Australia came online earlier this year amid weak lithium prices and is likely to weigh on earnings.

Faul estimates the joint venture represents a high-single digit percentage of Wesfarmers’ overall earning power, as part of the conglomerate's broader industrials segment.

Kmart’s market share

Faul expects that Kmart will have taken further share in H2 FY24 and forecasts this to continue into the new financial year. However, in the longer term Faul expects department stores to lose share to online retailers like Amazon and specialty brick and mortar stores.

Tax relief?

Like Faul mentioned in Morningstar’s Woolworths earnings preview, looming tax cuts could have boosted demand for Australian retail firms like Bunnings and Kmart in the second half of the financial year and give further sales momentum in FY2025.

Where is Wesfarmers stock sitting before earnings?

At a price of around $76.90 per share, Wesfarmers shares look overvalued relative to Faul’s Fair Value estimate of $43.00. As a result, the shares currently have a one-star Morningstar rating.

Faul’s Fair Value estimate is based on a forecast that Wesfarmers can grow its revenues by 4% per year over the next five years and achieve average operating margins of 10%. He estimates capital expenditures to average about 3% of revenue each year, a level broadly in line with the conglomerate's past 10-year average.

As mentioned previously, Bunnings generates close to two-thirds of Wesfarmers' earnings and is the most important driver of Wesfarmers’ top line.

Faul forecasts midcycle revenue growth at Bunnings of 6% per year, and for it to keep roughly 13% of its sales in pre-tax profits. By contrast, he expects Wesfarmers' industrials segment (which includes its chemicals, lithium and fertiliser operations) to see a single digit decline in annual sales over his forecast period.

Wesfarmers Ltd

  • Economic Moat: Wide
  • Star Rating:★
  • Fair Value Estimate: $43.00

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.