Broker JPMorgan has raised Wesfarmers to “neutral” from “underweight” as it anticipates higher sales and earnings from the tri-brand Kmart Group, and the potential for a $1 a share capital return at the next result in August.
Its valuation is $50.98 a share up from $46.52.
JPMorgan concedes its previous recommendation was “ineffective” in light of how well the business performed from the onset of COVID-19. Ahead of a Kmart investor day scheduled for April 20, it believes trading warrants an upgrade of earnings per share by 2.4 per cent in financial 2021 and 2.9 per cent in financial 2022.
The impetus for its upgrade is the performance of Kmart and Target, which alongside Catch, sit within the larger Kmart Group. The unique challenge of managing inventory during 2020 where Kmart elected to be “very conservative” in Australia was problematic for the business, and competitors Big W and Premier Investments were able to generate superior like-for-like sales growth with their bigger inventories.
Analyst Shaun Cousins concludes this wasn’t fully corrected until December last year. The core Kmart thesis remains high return on capital and with the benefits of significant capital investment. The forthcoming Kmart investor day may reiterate previous goals of $10 billion in sales, $1 billion of earnings before tax, and six times stock turns, the broker speculates, as well as an update on digital strategy. Conversions from Target stores are driving Kmart growth while Target is benefiting from less complexity and lower costs.
Catch is expected to be loss making at the EBITDA and EBIT levels “for some time as growth is the priority”. JPMorgan concludes it also enjoys significant market share headroom meaning lots of room to grow.
As such, Kmart Group EBIT was upgraded by 11 per cent to $794 million in financial 2021 from $713 million, and by a similar magnitude to $904 million from $811 million in financial 2022. Kmart Group will surpass $1 billion EBIT in financial 2023 if the broker is right.
JPMorgan projects the bigger Wesfarmers to earn $2.16 a share in 2021 and $2.13 in 2022 on an underlying measure.
“We expect $1 a share capital return to be announced in August 2021 as proceeds from the Coles sell-downs are redistributed efficiently to shareholders (as occurred in 2013 and 2014),” the broker said.
