Forum Topics WES WES 2023 Strategy Update

Pinned straw:

Last edited 2 years ago

30-May-2023: 2023 Strategy Briefing Day Presentation

View The Webcast: https://edge.media-server.com/mmc/p/6iyimda9

02-May-2023: Macquarie Australia Conference Presentation and Address by MD, Rob Scott

For all the latest WES results and presentations: Results & presentations (wesfarmers.com.au)

Today's 2023 Strategy Update (top link above) is long - at 104 slides - so I'm just going to reproduce the 4 that sum up this company best - in my opinion:

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So this isn't your average microcap or nanocap stock that is largely under the radar and could go to zero or multibag. No, this one is a large cap that just keeps grinding higher over time. The best way to check how a company has looked after their shareholders is to look at their TSR - Total Shareholder Return - which include share price appreciation and dividends, and assumes that all dividends were reinvested back into the company using their DRP. In this case they also assume full participation in all of WES' capital management initiatives over the years.


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Their TSR has well and truly outperformed the All Ordinaries Accumulation Index (XAO) which is represented there by that grey line. In fact, they've absolutely smashed it. Over that period, the All Ords Accumulation Index has performed almost identically to the ASX200 Accumulation Index (XJO). They both include reinvested dividends - that's the "accumulation" bit. Over shorter time periods there can be a little bit of divergence between the XAO and the XJO Indices, but they tend to have very similar returns to each other over decent time periods, like decades. WES, however, has done a LOT better than both of them.

Disclosure: I hold WES shares in real life and here on Strawman.com.


OK, one more slide:

How's this for a mission statement: Their primary objective is...


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Tick.

Solvetheriddle
Added 2 years ago

Re WES, this is pure indulgence on my part and my favourite WES story. as you may recall WES got caught out badly with the Coles takeover. they wanted the supermarket but were less keen on target and Kmart as i recall, and had lined up PE firms to help fund these acquisitions. as the GFC unleashed itself, the PE firms ran for the hills and WeS was left to fund the lot, solly lew having sold out at an extraordinary high price beforehand. WES needed 2 rights issues to get by, near the share price lows. i dont think Goyder (WES CEO) was ever properly taken to task over that. they did turn coles around in due course, and made up for that error of risk management.

anyway we were talking to goyder later in the middle of the GFC and he told us how difficult it was to secure funding, the banks were pulling credit lines everywhere, even a top credit like WeS was finding it really difficult. that was a timely call, because our next call was a resource mid cap that needed funding. we asked the ceo if he had credit lines in place and he told us no but that would not be a problem. we ran for the hills, saved us a fortune......oh the memories

WES disc. i hold as an income source. they are reasonable capital allocators imo

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Strawman
Added 2 years ago

It really is hard not to be impressed with Wesfarmer's long term performance. I agree @Bear77, it just manages to keep grinding higher -- a solid 'bottom drawer' -type stock.

What's interesting is that while shares have delivered almost 17% pa compound return over the last 5 years, Wesfarmers EPS and DPS has grown at less than 2.5% annually over the same. For a 50 billion giant in relatively mature segments, that's not that awful. I don't think you could realistically expect much more than 5% average annual growth in cash earnings over any extended period of time.

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The obvious explanation here is that since 2017 the average annual PE has lifted from 16 to 26 -- That is what has done the heavy lifting in terms of shareholder returns.

You'd never knock it back, but to my mind investors cant expect multiples to continue expanding at that rate forever. After all, 26 is pretty high for a company that has been growing at low single digits, and where the consensus forecast for EPS growth over the next 3 years is 6%pa.

Of course, with a 3.5% fully franked yield, if dividends can likewise show the same growth you probably still end up with a decent return (especially on a risk adjusted basis and accounting for franking credits). So long as multiples dont contract too much..

You can't predict future PEs, but i tend to find it sensible to at least assume a PE more in line with historical norms. You want the company itself (not sentiment) to do most of the work.

As an example, let's say Wesfarmers shoots the lights out and grows EPS at 12% per year for the next three years --- double the consensus guidance -- BUT let's also assume the PE reverts from 26 to 18. The average annual capital gain is only 2%. Let's call that 5-6%pa as a total return with dividends included. Not a disaster, but not great. If you assume a PE of 16, you make a capital loss.

If EPS growth is more like 8%pa over the next 3 years -- still a good way above consensus -- you need a future PE of about 19 just to break even (excluding dividends).

You can make the same argument with Woolies, which is on a PE of almost 28.

I'm not saying PEs will contract, just that they are presently quite high relative the historical average. And to do well from here you really cant afford the PEs to shrink too much.

It's my contention that the market is not naive to the reality of future growth, and the fact that the current valuation is a little stretched. But it is placing a big premium on safety given the various economic storm clouds on the horizon (real or perceived). These are massive, highly liquid and very dependable businesses that will endure for a long time. Buying now is not about finding a market beating return -- it's about long term capital preservation. Well, that's the only way I can explain it (open to other theories).

All that being said, if i held this in my super or something, and I intended to hold for a long, long time, I probably wouldn't fiddle too much. Yeah it's a bit pricey, but I can probably get a fairly reliable income stream and at least outpace inflation over the coming years. The whole idea with bottom-drawer stocks is that you just sit on them, and although you'll experience periods of over-valuation, it'll probably work out really well in the very long run.

I just don't expect the total shareholder return to average double digit rates over the next 3-5 years.

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Bear77
Added 2 years ago

Well articulated @Strawman - yes, they are not cheap, but they are dependable in terms of being profitable and shareholder returns focused. I agree that the PE could come down, but I also maintain that there is a quality premium in the share price that could easily be maintained if we continue to experience volatile markets or volatile economic conditions. My idea is that I use companies like WES as cornerstone positions in diversified portfolios and give them a decent weighting, but give higher weightings to companies that look to have more upside in terms of PE expansion and growth, such as Codan (CDA), which is a larger position than WES in my portfolios. They won't go up in a straight line, but they will provide some very decent TSR's over decent time periods.

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Bushmanpat
Added 2 years ago

I became a WES shareholder when they took over CML and have been happy with the returns since then. With the DRP and the odd capital return, they just tick over doing their thing. I agree they make a good cornerstone position which gives me, well confidence isn't quite the right word but in lieu of the word I'm looking for, I'll run with it, to better back my conviction in some of the more early-stage companies I'm interested in.

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Strawman
Added 2 years ago

I agree with all of that. You don't want to overthink things too much when you're talking about high quality businesses. And waiting for high quality companies to get to very low PEs is usually counter-productive!

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Bushmanpat
Added 2 years ago

That's why we're here isn't it. To find small growing companies on excellent PEs so our older selves can hold high quality businesses on reasonable PEs with good income. Which gives us some extra cash to find small growing companies......

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Rick
Added one year ago

I couldnt help to weigh in on the Wesfarmer’s discussion. I don’t own WES because it always seems to be very well priced. That in itself says a lot about the business in regards to the quality and consistency of its earnings.

There has been a lot of reference to the PE and earnings growth, but I’m surprised no one has mentioned ROE. ROE is always the first metric I look at when I get interested in a business (surprise, surprise!)

A quick look at the historical ROE trend says a lot about why the WES share price has done so well.

Take a look at the ROE growth over the last 9 years. ROE has climbed from 8.7% in 2014 to 29.7% in 2022 without falter. This chart is probably the most consistent improvement in ROE I’ve seen of any business . What’s more, future ROE is rxpected to be 32.6% based on forecast earnings. This might help to explains why the PE has lifted from 16 to 26 since 2017.

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Source: Commsec

@Strawman raises a good point though. Why is earnings growth single digit, particularly when ROE is 32.6%. The answer is simple, only 20% of future earnings is likely to be reinvested into growth, 20% x 32.6% = 6.5%. But that’s not the total of shareholder cash returns.

Rather than hypothesising returns based on what the PE ratio might or might not be in the future, what if we assumed we never sold the business and worked out our annual rate of return?

What annual return could we expect if we paid $47.67 (the current share orice) for $7.11 worth of equity (current equity) in the business which is forecast to return 32.6% on equity per year.

To value a business using McNivens StockVal formula we usually determine our required rate of return considering risks associated with the businesss and future earnings.

Alternatively we can use the current share price as the valuation and then work backwards to find out the annual rate of return.

This is difficult to do manually using the formula, but using a spreadsheet you can substitute different rates of return until you come up with the current share price as the valuation.

When I did this I came up with an annual return rate of 8.8% (including the franking credits).

You need to consider the level of risk you are taking for a total 8.8% annual return. You also need to be confident WES can maintain a ROE of 32.6% because a lower ROE will also result in a lower annual return for its shareholders.

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Strawman
Added one year ago

Great point @Rick

Another thing to consider is the conglomerate business structure. Woolies growth is largely about the growth it can carve out in the mature supermarket sector (unless it embarks on a far broader strategy). Wesfarmers can, and does, invest in all kinds of industries. Everything from lithium and ammonia to health. They could invest that 20% of retained earnings into an entirely new business, and that could have an incremental return on equity that is also very attractive (or not).

So the bigger picture 'bet' here is not just their ability to run their assets well, but to find and invest in new opportunities (and recycle capital out of less attractive ones). And here there's a pretty good track record.

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Rick
Added one year ago

Great points @Strawman. This is what I really like about this community. Discussions like these. It gets you thinking much deeper than you normally would about investing, businesses, and what makes a difference. This leads me to my next thought.

Before I do, I must admit to a little error I made working out the forward annual return to shareholders for Wesfarmers. I had 16% reinvested earnings entered into my spreadsheet for WES (last years figure), rather than their average of about 20%. Changing this by 4% increased forward returns from 8.8% to 9%.

However, this little error got me thinking. What if Wesfarmers could reinvest 50% of its earnings back into growth at the same forecast ROE of 32.6%. It would be extremely difficult for them to do this, but this tweak in the spreadsheet increased shareholder earnings from 9% to 11% per year at the current share price of around $48.

Then I thought, what if Wesfarmers could reinvest 50% of their earnings at 32.6%, and we leave shareholders annual return at 9%. How would this affect the current valuation? I was surprised to see the valuation jump from $48 to $65 per share. There a strong message here.

It’s these ‘what if’ scenarios that get you thinking about other possibilities and other businesses.

Now I want to explore how many businesses fit into the 30-50 club, ie. at least 30% ROE and at least 50% reinvested earnings. Technology One is certainly one business in the 30-50 club with forward ROE of 33% and reinvested earnings close to 50%. But sigh…at a forward PE of 55x it does appear to be fully valued. There must be others in the 30-50 club with a lower PE than 55x, surely? Ah yes…Mader (MAD)! I shouldn’t have let that one go either!

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