Popular Dividend Stock with a Target’ed Rational Strategy: Wesfarmers

Summary

• Wesfarmers on track to accelerate Kmart growth and address unsustainable Target’s financial performance.
• Target’s restructuring to deliver overall value for the group.
• Wesfarmers believes dividend, credit rating remains intact for FY20.
• WES stock continues to remain under radar with relentless focus on customers, portfolio repositioning and balance sheet flexibility and capacity.

Since Wesfarmers (ASX:WES) has introduced its restructuring plans, it may have sparked a rethinking across the industry on the need for more stores. As online retail and omni-channel retail experience are gathering momentum, the requirement of more stores remains lower.

With portfolio of cash-generative businesses focused on long-term value creation, Wesfarmers is responding to the uncertainties of COVID-19 from a position of strength with dedicated actions to reposition the portfolio. Moreover, the company is going great lengths on its relentless focus on customers, investing for the long term and building on unique capabilities and platforms, with continued focus on balance sheet flexibility and capacity.

Post bottoming at $31.020 on 23 March 2020, WES has soared by ~32%. The stock closed the day’s session at $40.700 on 26 May 2020.

Besides, with a dividend yield of 3.87% WES seems to be under the spotlight among dividend investors looking for attractive stocks with decent yields and payout history.

Target store closures and restructuring plans

Amidst COVID-19, WES reported strong sales momentum in Bunnings, Officeworks & Catch, but with recent decline in shopping centre footfall impacting Kmart & Target.

In view of the same, Wesfarmers has recently completed the first phase of Target review. As a result, the group has announced a range of measures to optimise the cost base of the Target stores. Under the plan, it would convert 10 to 40 large format Target stores to Kmart stores, depending on landlord support.

A few above 50 Target Country stores would be transformed to Kmart small format stores. Kmart Group would close the rest 50 Target Country stores that could not be converted to Kmart stores, with 10 to 25 large format Target stores. The group continues to negotiate with landlords for a sustainable store network. There would be a significant reduction in the size of Target store support staff.

These strategies would be implemented over the coming months with a majority in CY21. It is intended to improve the financial performance of the group and deliver a better return on capital.

Conversion of some Target stores to small format Kmart stores stems from the small format Anko stores in the US. This would allow enabling the group to provide regional customers with access to Kmart’s apparel, general merchandise and home categories.

Kmart Group has experienced strong growth in online sales and an increasing number of customers who prefer to shop online. Therefore, the group is committed to investing in digital infrastructure of the business. It would expand the click and collect offering of the Kmart Group.

Also, the group continues to look for strategical options for the Target stores that are commercially viable and remaining stores. Additional updates on the strategic review would be provided during the full-year results released in August 2020.

Target stores that would be converted to Kmart stores will have their employees onboarded to Kmart Group. Also, the employees impacted due to store closures are expected to be mapped for the new roles within the Kmart Group.

Wesfarmers will also try to redeploy affected team members to other businesses, including Bunnings and Officeworks. Most of the Target store closure plans are scheduled for 2021, providing ample time to redeploy employees to new roles.

Items impacting FY20 results

Due to lower support staff, inventory write-offs, and store closures in Target, Kmart Group would incur restructuring and provisions cost between $120-170 million before tax. An impairment of Target’s assets and obligations would result in a non-cash impairment of $430-480 million (pre-tax).

It would incur non-cash impairment of around $300 million (before tax) in Industrial & Safety division related to goodwill. There would be a gain on sale of a stake in Coles Group of around $290 million (pre-tax), and revaluation of remaining interest in Coles Group would translate to a pre-tax gain of $221 million.

As majority of items are non-cash in nature, Wesfarmers believes that dividend, credit rating and debt facilities would not be impacted for the financial year 2020.

Related: Resilient retail businesses with earnings show: WES, LOV, DMP

Kmart Group half-year results

In the half-year ended 31 December 2020, the group posted a profit after tax from continuing operations of $1,127 million and revenue from continuing operations was $15,249 million. Moreover, the group noted revenue of $4.9 billion and earnings before tax of $343 million, after implementing AASB 16.

Within segments, Bunnings delivered revenue of $7,276 million and segment result of $938 million. Kmart Group’s revenue was $4,990 million with a segment result of $343 million. WesCEF recorded revenue of $889 million and segment results of $173 million. WIS delivered revenue of $858 million and segment result of $7 million. And, Officeworks recorded revenue of $1,231 million and segment results of $82 million.

Target incurred cost of $9 million related to payroll remediation and its total sales were down 4.3% over the previous year or by $67 million. Lower sales were attributed to reduced customer transactions with poor performance in Apparels.

Excluding Target, other segments within the group performed strongly during the half-year period. Newly acquired Catch delivered revenue of $155 million while also enhancing the online capabilities of the Kmart Group.

Target’s earning was positive for the period, but it was lower significantly compared to the same period last year. Kmart Group also invested in digital and retail technology, including investment in Anko.

During the period, four Target stores were closed, and five new Kmart stores were opened. At the end of the half-year, Kmart Group was operating 521 stores.

It was said that Target’s operational performance is unlikely to improve in the near term. Management was expecting to continue to lower costs of the Target stores, with continued investment in digital capabilities by Kmart Group.

Related: Retailers Face Ongoing Disruptions from COVID-19 and Increasing Wage Bills

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