Strat­egy: Greg Hoff­man Break­ing down a blue chip

It can be tricky as­sess­ing the value of a large, di­ver­si­fied con­glom­er­ate, es­pe­cially one that brings in $68 bil­lion a year

Money Magazine Australia - - CONTENTS -

Quiz ques­tion: which is Aus­tralia’s largest com­pany by rev­enue? Did you think of “the big Aus­tralian”, BHP Bil­li­ton? Not a bad guess. It’s third, with about $ 49 bil­lion in rev­enue. Or per­haps you plumped for Wool­worths with its su­per­mar­kets, Dan Mur­phy’s liquor chain and petrol re­tail­ing op­er­a­tions (BP has agreed to buy th­ese op­er­a­tions but let’s still count them). That’s an even bet­ter guess. It’s sec­ond with a mighty $61 bil­lion.

Now pat your­self on the back if you an­swered Wes­farm­ers (ASX: WES), the Perth-based con­glom­er­ate that pro­duced $68 bil­lion in rev­enue in the 2017 fi­nan­cial year. With the com­pany’s share price roughly where it was 10 years ago, I re­cently took a closer look to see if it might of­fer some value. Here’s how I went about it and what I found.

BLIND MEN AND THE ELE­PHANT

Ap­proach­ing a di­ver­si­fied group like this can be a bit like the parable of the blind men de­scrib­ing an ele­phant – each part is quite dif­fer­ent. To bring it to­gether, I’ve ap­plied an ap­proach called “sum of the parts”. This in­volves tak­ing each of Wes­farm­ers’ busi­nesses in turn and con­sid­er­ing them in­di­vid­u­ally be­fore adding them to­gether to ar­rive at the to­tal. Let’s start with Bun­nings.

Bun­nings achieved $11.5 bil­lion in rev­enue in Aus­tralia and New Zealand in 2016-17. Con­trast that with Coles, Wes­farm­ers’ other pri­mary busi­ness, which pro­duced more than $39 bil­lion. Yet Coles man­aged a profit mar­gin of just 4.1% (down from 4.7% in 2016) com­pared with an im­pres­sive 11.6% at Bun­nings (up from 11.5%).

When it all comes out in the wash, de­spite Coles pro­duc­ing 3.4 times the sales of Bun­nings, it de­liv­ered only 20% more profit to Wes­farm­ers’ bot­tom line. Bun­nings also faces a calm com­pet­i­tive out­look fol­low­ing the demise of Masters, the com­peti­tor launched by Woolies and US hard­ware gi­ant Lowe’s. So if Bun­nings Aus­tralia and New Zealand were it­self listed on the ASX, how much might it be val­ued at?

If we sub­tract 30% tax from its $1334 mil­lion of op­er­at­ing profit, we’d end up with a net profit of $934 mil­lion. Given the facts above, I be­lieve the mar­ket would value the busi­ness on a price-to-earn­ings ra­tio of be­tween 18 and 24. That’s higher than av­er­age but this is a su­per-high-qual­ity busi­ness. You can see the re­sult­ing val­u­a­tions in the ta­ble op­po­site.

Let’s stay with the ta­ble for a mo­ment. Un­der­neath Bun­nings Aus­tralia and New Zealand, you’ll see a sep­a­rate line for Bun­nings UK and Ire­land (UKI). In

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