Wesfarmers reported modest EBIT growth of 3% in FY24 with low growth for Bunnings, a decline in WesCEF and strong rise in Kmart EBIT the notable factors. Bunnings earnings growth is likely to remain low over the next two years given limited store openings and a challenging demand backdrop. We think Kmart’s margins are near a peak, particularly given price competition with rivals is heating up. WesCEF and lithium become the key driver of Wesfarmers earnings from here and it will take up to three years to see meaningful earnings.

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 reported 1% sales growth and 2% EBIT growth for 1H24. The result revealed meaningful growth from Kmart and a large decline in WesCEF. Bunnings EBIT rose by 0.4%. The primary drivers of the result were improved gross profit margins and a tight control on costs given high underlying cost inflation. For WesCEF, reduced prices in ammonia and lithium will result in a difficult 2H24e. Kmart is at peak margins and ongoing cost pressures will limit margin expansion across retail in our view.

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.

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.