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
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