Aussie conglomerate daringly bucks breakup trend – Reuters

An Australian flag is seen hung in a tree burnt by bushfire on the property of farmer Jeff McCole in Buchan, Victoria, Australia, January 23, 2020. REUTERS/Andrew Kelly – RC25YE9UJ4VL

MELBOURNE, Feb 14 (Reuters Breakingviews) – It would be understandable if a company with agricultural roots simply followed the herd. Instead, A$60 billion ($43 billion) Wesfarmers, whose origins trace back more than a century to a farming cooperative, is daring to defy the global breakup trend enveloping many of its fellow conglomerates. The numbers are on its side for now, but the Australian company is just one bad deal away from getting swept up in the backlash.

Wesfarmers is a classic collection of misfits. It sells hammers to homeowners, T-shirts to teens and markers to middle managers. It’s also mining for lithium, producing liquified natural gas and manufacturing sodium cyanide for gold extraction. There are stakes in an investment bank and a supermarket-shoppers loyalty programme in the mix, too. Unlike the typical jack-of-many trades, however, it is delivering robust shareholder returns and isn’t suffering any obvious hodgepodge discount, based on Breakingviews calculations.

Such business models are again under fire. General Electric , Johnson & Johnson (JNJ.N) and Toshiba (6502.T) are among those dismantling their empires. Unilever (ULVR.L), Shell and 7-Eleven owner Seven & I all face pressure from shareholders to do the same, while trustbusters increasingly challenge Meta Platforms (FB.O) and other U.S. technology goliaths for their multipronged dominance. Even smaller and more narrowly structured companies such as Kohl’s (KSS.N) and De La Rue (DLAR.L) are up against pushy investors urging them to break up.

This latest market mutiny has not made its way yet to the hermetic mining state of Western Australia, where Wesfarmers started life nearly 108 years ago as Westralian Farmers Ltd to help rural growers sell produce collectively. After a brief spate of purging a few years ago, the Perth-based giant is back adding to its sprawl by acquiring drugstores and maybe a veterinary service.

GENETIC ENGINEERING

Diversification is in the Wesfarmers DNA. A decade after its founding, it established the first commercial radio station in the region to broadcast crop prices. It moved into distributing liquefied petroleum gas after striking a deal with BP in the 1950s.

Its A$60 million bid in 1977 for a fertiliser maker three times its size was “the largest takeover Australia had ever seen,” according to a potted history on the company’s website. Wesfarmers set another national M&A record 30 years later when it agreed to buy the Coles (COL.AX) grocery chain for some A$21 billion, a purchase that included the Officeworks office-supplies network and the domestic Kmart and Target operations.

Owning an assortment of assets is working to plan for Chief Executive Rob Scott. Wesfarmers issued a blunt warning last month about how pandemic-related disruptions were hurting the two discount retailers and online marketplace Catch because of store closures, rising freight costs and warehouse staffing problems. Meantime, the Bunnings hardware chain and the chemicals division sufficiently hummed along to keep the overall profit target on track with consensus estimates.

“We don’t think of diversification for the sake of diversification in investment decisions,” Scott told investors during a strategy briefing in June when asked about capital allocation. “We’re more focused on absolute returns. We think that we’ve got a phenomenal mix of businesses that represent both quite a unique balance between defensiveness, high cash generation, but also good growth perspectives.”

The financial performance, despite a dearth of obvious synergies, helps insulate Wesfarmers from the wider breakup braying. Over the past decade, it has generated an average annual total shareholder return of about 22%, more than double Australia’s benchmark index. It also outperformed GE, J&J, Toshiba, Unilever, Shell, Seven & i, Kohl’s and De La Rue during that span.

POWER TOOLS

Bunnings accounted for nearly 70% of Wesfarmers’ earnings before tax in the last full financial year to June 30, excluding impairments, restructuring costs and other significant items, with a healthy operating profit margin of nearly 14% and 12.5% top-line growth to boot. The well-managed home-improvement brand resonates especially well in a housing-obsessed country.

Partly for that reason, fund managers seem to just think of Wesfarmers as Bunnings. The whole enterprise trades at about 18 times expected operating profit, roughly on a par with Home Depot’s valuation, according to Refinitiv data, even though most of the remaining divisions don’t warrant that kind of premium.

After applying lower EBIT multiples to Kmart and other units, using divisional forecasts from Macquarie analysts and worldwide peers chosen by Breakingviews, the five main Wesfarmers groups would be worth some A$54 billion. Throw in public-market holdings and private-stake estimates from Jefferies while backing out net debt, excluding lease obligations, and corporate costs, and the parts tally up to the same A$60 billion sum as today’s equity value.

The framework is precarious, however, and can be shaken even by small acquisitions. Wesfarmers in 2016 attempted to export its Bunnings knowhow by paying 340 million pounds for British peer Homebase. Despite careful preparations, the deal turned out to be a management distraction and a financial mess. A portfolio shakeup ensued.

After abandoning an initial public offering plan for Officeworks in 2017, Wesfarmers offloaded Homebase to turnaround specialists, spun off the capital-intensive Coles supermarkets and sold stakes in a thermal coal mine and oil and gas producer Quadrant Energy. Before long, though, Scott was using his newly healthy balance sheet to go shopping again.

The latest addition is set to be Australian Pharmaceutical Industries (API.AX), which will put Wesfarmers into the health and beauty industry after it won a heated bidding war last month for the A$750 million operator of the Priceline Pharmacy chain and others. It is also sniffing around the sale of the pet retail and medical care business Greencross, according to Australian Financial Review.

If Scott sticks to bite-size expansion at home, rather than mega-deals and overseas misadventures, he might keep successfully warding off the carve’em-up crowds. There’s also probably valuation uplift available by parting ways with some of the slower-growing, low-margin businesses. Even then, Wesfarmers could wind up one of the last conglomerates standing.

Follow @jgfarb on Twitter

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

Editing by Antony Currie and Katrina Hamlin