Can Bunnings save the Wesfarmers Ltd (ASX:WES) share price?

Can Bunnings Warehouse save the Wesfarmers Ltd (ASX: WES) share price?

If you asked me a year, six months or even six weeks ago, I would have said Wesfarmers was one of the best blue-chip ASX dividend shares on the market.

The owner of Bunnings, Officeworks, Kmart, industrial businesses and a resources-focused business has a long and rich history of resilience, providing healthy free cash flows, dividend income and mid-single digit earnings growth.

However, with the latest Coronavirus restrictions put in place in Victoria, Bunnings is, like all retailers, going to feel the pinch. This is especially true if states like New South Wales and Queensland unfortunately follow Vic down the path of tighter restrictions.

Tighter COVID restrictions could bite Bunnings

Like Harvey Norman Holdings Ltd (ASX: HVN), Reece Ltd (ASX: REH), JB Hi-Fi Ltd (ASX: JBH) and many others, Bunnings will soon be forced to go just about completely online. With a ‘click and collect’ style arrangement the only offering allowed under the new restrictions, Victorian shoppers will not be able to enter retail stores.

As a Bunnings and home DIY tragic, I’m shattered. But I’ll probably save a lot of money…

According to reporting by The Australian, before the latest Victorian Government announcement today, Bunnings Managing Director Mike Schneider said the retail outlet played an “essential role” in helping Aussies keep their houses standing and his store network took “pressure off the supermarkets” because they supplied cleaning products.

Alongside changes to the construction sector, including a rule of no more than 5 people on a domestic worksite, it seems the Government is taking a tougher stance on what is — and what isn’t — an essential way to do business.

What now for Wesfarmers shares?

In June, Wesfarmers reported Bunnings had achieved year-to-date sales growth of 11.3% compared to the same period in 2019. That’s not surprising, given the long queues of people lining up to get inside lately.

“Significant demand growth has continued in Bunnings and Officeworks as customers continue to spend more time working, learning and relaxing at home,” the company said in June.

Based on the financial results from the first half of its 2020 financial year, Bunnings accounted for around 60% of Wesfarmers’ profit before tax. Indeed, the recent momentum, driven by more folks buying online and using the lockdowns as an opportunity to do maintenance and renovations, is a good thing.

However, eventually, the adverse impacts from a weaker economy will catch up with the business’ bottom line.

For me, the questions are:

  • How far does profit fall? And…
  • For how long?

Wesfarmers is due to report its full-year financial results on or around August 20th, 2020. According to analyst estimates from Bloomberg, the company should achieve a profit of around $2 billion. That would compare to a profit of $1.94 billion last year — implying 3% growth.

What is the Wesfarmers share price worth?

Using these latest forecasts, plus an assumption about dividends, we can do a valuation of the shares.

If we assume Wesfarmers shareholders receive a final dividend of $0.74 per share (the current analyst consensus forecast), together with the $0.75 in half year dividends already paid, that’s about $1.50 in full year dividends. With that as our base case we can estimate the valuation of Wesfarmers shares using a Dividend Discount Model (DDM), which takes future dividend payments and discounts them back to today’s dollars.

Applying a risk rating of 8% and a long-term growth rate of 3%, my quick and simple valuation of Wesfarmers shakes out to be about $34.90 per share. Assuming growth of 4% per annum, which is reasonable in my opinion given Bunnings’ virtual monopoly on the DIY home improvement market, my Wesfarmers valuation jumps to $43.63.

This means, a reasonable back-of-the-evelope valution of Wesfarmers shares is probably somewhere between $35 and $44. Compared to the current Wesfarmers share price of $46, my valuation range hints at only a slight over-valuation. However, my valuation is quick and rough, so take it with a pinch of salt. To learn more about dividend valuations, take our free stock valuation course or watch my video above in which I analyse Woolworths Ltd (ASX: WOW).

Buy, hold or sell?

As a long-term investor who’s always admired Wesfarmers for its dividend potential (and its Bunnings stores), I’ll be watching the company closely to see if/when I can pick up shares on the cheap. Bookmark this page in your web browser and check back on Rask Media in late August for all of the latest reporting on Wesfarmers shares.

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At the time of publishing, Owen does not own any shares in the company mentioned.

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