From a hiccup to a tremor By Philip Rennie Wednesday, February 26, 2003
img src="http://www.brw.com.au/images/mini_rennie.jpg"> Silver linings are hard to find these days. Investors can only hope that excessive reactions to company news, so apparent recently, are a symptom of the bear market's final stages. For example, on February 11, when Wesfarmers announced a minor hiccup in its results for the half-year to December 31, 2002 - not a profit fall, but a tweak in second-half outlook - its share price fell 14%, from $28.25 to $24.20.
Market historians say that gloom, pessimism and over-reaction indicate a bear market is coming to a close. One thing is certain: the Australian market's stoicism has vanished in 2003. In the current profit reporting season, news that would normally cause a ripple is turning investors, especially institutions, into panic sellers.
Wesfarmers has been one of the market's favored growth stocks and still has a strong earnings outlook. Chief executive Michael Chaney modestly described the 25% profit rise for the December half-year as "solid". In fact, it was the usual strong growth. Then came the panic point for institutions. Directors expect a reasonable increase in profit, Chaney said, but "it will be difficult for the group to achieve its original full-year budget".
Reading this, analysts have slightly trimmed their profit increase forecasts for 2002-03, although hardly enough to justify the share price dive. For instance, Merrill Lynch's after-tax profit forecast for Wesfarmers' full year was reduced by 5%. However, because the profit revision is largely due to the drought, which, it is hoped, will end with autumn rains, Merrill Lynch has reduced its 2003-04 profit forecast by only 1%. The broker still expects strong growth, with profit rising from $413.9 million for 2001-02 to $487.8 million for 2003, $575.8 million for 2004 and $643.8 million for 2005.
Looking at hardware retailing, Wesfarmers' biggest division, Chaney reported that operating revenue rose by 16% in the half-year and earnings before interest, tax and goodwill amortisation was up 35%. These are strong figures, but there was a note of caution. Sales were softer than expected in December, and that continued into the new year. Water restrictions in many parts of Australia hurt sales of garden products and there was unseasonably hot weather in some areas on key selling weekends. Sales in the current half are expected to soften as house construction slows. However, the Bunnings hardware stores are still expected to meet their budgeted full-year profit.
The energy division, including coal mining and gas processing, has a sound outlook, although the outcome of annual coal price negotiations will affect results in the final quarter of 2002-03. Industrial and safety products had a good half year and outlook. The rural division suffered from the drought, as did the 50%-owned Australian Railroad Group. It operates in Western Australia and South Australia where the grain harvests, which form a substantial part of its freight business, were severely reduced.
It is interesting to look again at what Chaney said about the group profit outlook. No doubt choosing his words carefully, he said the full-year budget would be difficult to achieve, not that it would certainly not be achieved. Autumn rains, coal prices and retail trends were important variables, he said.
Wesfarmers' balance sheet is strong, with gearing well below target levels. As a result, the dividend re-investment plan has been suspended and the company may buy back up to 5% of its shares over the next 12 months. Such moves will moderate the effect of any profit fall on earnings per share.
These capital management moves do not point to any change of philosophy on acquisitions, which have powered Wesfarmers' conversion from rural co-operative to dynamic growth stock. Chaney says the buyback will not constrain expansion plans. He takes his time about acquisitions and will not pay more than his own team's valuation, but there are always targets in the company's sights. Takeovers will be required to keep the long-term growth rolling.
The dividend for the December half-year was increased by 24% to 42¢ per share fully franked and, based on analysts' profit forecasts, further substantial rises are in prospect for the next few years. At the share price of $24.45 on February 17, the dividend yield for 2003 seems likely to exceed 5% and rise substantially if dividend growth assumptions for the next few years prove to be correct.
This is an attractive yield from one of the best growth stocks of recent years. Retail investors might prefer to focus on this rather than the perceived need to cut Wesfarmers' price/earnings multiple, which influenced institutional sellers after the company's earnings announcement. Retail investors will have their own views on what constitutes value. For most, dividend yield will figure strongly in this, particularly in a bear market. When flights of bull-market fancy are just a memory, yield is the ultimate fallback position.
