Wesfarmers held its annual strategy day and, as always, delivered a consistent message about its focus on long-term shareholder value creation.  The tone of Wesfarmers annual strategy presentation focused more on growth initiatives and highlighted the progress on productivity and technology investments. While a positive presentation, the detail is unlikely to change consensus earnings expectations and the share price remains very stretched.

Wesfarmers’ strategy day highlighted its growth projects and market share opportunities, despite an increasingly challenging economic environment. The businesses may be relatively resilient, but they are not immune. The combination of slowing sales and rising operating costs keep us cautious.

Wesfarmers reported a strong 1H23 result with EBIT up 13% to $2,160 million. The strength largely reflects good retail earnings and higher chemical and fertiliser prices. Even so, Bunnings profit margins declined and the good group result was partly overshadowed by a very large loss for Catch Group. The prospect for earlier lithium sales will help earnings in FY24e, although project capex is higher.

Wesfarmers strategy day was as comprehensive as usual but did leave us with a few unanswered questions about the finer details of its digital plans, capex outlook and Health ambitions. We expect growth in trade for Bunnings will be difficult without capex and the digital opportunity will take time to build traction. We remain cautious on Bunnings sales outlook.

We would not ordinarily preview a strategy day, but Wesfarmers event on 2 June 2022 will be more interesting than usual given the importance in understanding its digital strategy and its Health segment ambitions. We have outlined the key questions on our mind. While Wesfarmers has very strong existing retail businesses, the future direction and capex required make us cautious about the earnings outlook.

Bunnings accounts for 63% of earnings at Wesfarmers. While a strong business with a leading market position, Bunnings faces challenges in continuing to take market share in our view. The two major areas of share gains are in online and trade. However, in order to succeed in trade and online, Bunnings may need to spend significant capex overhauling its supply chain. At this stage, we do not expect any major shift in supply chain strategy and as a result have modest sales growth and flat margins over the next three years for Bunnings.

We initiate coverage on Wesfarmers. While Wesfarmers retail businesses are well positioned, they have seen significant benefits to sales and earnings over past two years, which will partly reverse. As a result, retail earnings could drop over the next two years. A special dividend is possible near-term. Wesfarmers has over $10 billion in acquisition capacity on our estimates, but in recent times has only made smaller adjacent acquisitions within existing businesses. The creation of a Health segment is one logical extension for the company with an Australian healthcare industry EBITDA profit pool of over $28 billion.