Wesfarmers CEO Rob Scott faces a choice that could well define his time at the helm of the company.
The company’s remaining retail business (after the Coles spin-off in late 2018) might be about to stutter with the news that the once mighty Kmart department store chain had stumbled in the six months to December.
Up to Monday’s close Wesfarmers’ shares were down 17% in the past six months as investors wondered about the impact of the Coles spin-off and if the remaining retail assets, led by Bunnings and Kmart, would continue to power growth.
Bunnings seems to be performing to budget, but Kmart saw its first dip in same-store sales for around 8 years in the six months to December.
As a result earnings from Kmart and its associated chain, Target would come in at between $385 million and $400 million, compared to $415 million in the same half last year and well under analyst forecasts around the $450 million mark.
That is a significant miss for a chain that has been the best performer in Australian retailing outside of its sister chain, Bunnings.
Wesfarmers said at its annual general meeting on November 15 that Kmart’s trading had slowed from the same period in 2017 when comparable sales grew 5.4%.
Kmart’s sales momentum slowed further in November and December, and for the half-year just ended sales fell 0.6% on a comparable basis.
Topline sales, which includes the impact of opening new stores, grew just 1%, against the very strong 8.9% in the December, 2017 half year.
Analysts are now looking to Wesfarmers to reveal a revival strategy by the time of its interim earnings release in mid-February – CEO Scott made it clear on Monday that the chain will slow its aggressive price cuts.
But analysts and big shareholders are wondering whether Scott and the board will use a big improvement in the company’s financial position to launch a big acquisition (perhaps as a way of diverting attention from the Kmart woes).
Monday’s statement from the company revealed that Wesfarmers had cut net debt from $3.6 billion at the end of the 2017-18 financial year to just $300 million following a string of asset sales last year.
That was $500 million less debt than the market had expected and triggered a burst of predictions about capital management moves, such as a share buyback.
Wesfarmers said on Monday it expected to gain between $2.1 billion and $2.3 billion from the November demerger of its Coles supermarket division (a non-tax paper profit), $670 million to $680 million from the sales of its stake in the Bengalla coal mine, and $265 million to $275 million from it’s Kmart auto business (both taxable).
But Mr. Scott seemed to be interested in stoking speculation about a possible deal in a number of media interviews he did on Monday.
“We think the opportunities from an M&A point of view are better than they were six months ago given the market has come off a bit and we’re seeing ongoing volatility in capital markets,” Mr. Scott told Fairfax Media.
“Often you find that good investment opportunities arise at times of market volatility, so we’re well positioned should those opportunities arise.”
A capital return to shareholders was also on the cards, Mr. Scott said in the media reports.
Wesfarmers now has a surplus of franking credits building up following the sale of its stake in the Bengalla coal mine, Kmart Tyre and Auto and Quadrant Energy in 2018, so a return could happen.
But given the dud performance the previous CEO, and the board had in mergers and acquisitions (eg: the costly UK Homebase deal which cost Wesfarmers well over $1.2 billion), many analysts are wary about a big buy and would prefer a capital return to shareholders.
A capital return would show Mr. Scott as a steady manager, a big takeover would indicate a lot of risk, especially with the economic outlook clouded by uncertainty, and the unresolved problems in Kmart.
