Why the drop ?, page-34

Have pasted some negative WES estimates (& pro WOW) below fyi and so that I can easily come back to review it after FY2016 results. I hope David Errington is wrong, but I did hear somewhere he is highly regarded, time will tell.


Wesfarmers profit to fall by 8pc in 2016: BAML
THE AUSTRALIANMAY 24, 2016 9:47AM

John Durie
Senior writer/columnist

Wesfarmers profit will fall by eight per cent this year and the company will likely be forced to cut its dividend due to a $300 million-plus fall in coal earnings and lower margins for its general merchandise retail division, according to BAML analyst David Errington.
Errington’s downgrade comes as the Wesfarmers board is in the middle of its annual four-day strategy session in Margaret River.
In a note released today, Errington said Wesfarmers’ first-half earnings were boosted by $251m in advantageous currency hedging positions which are now coming to an end.
This will hit Kmart’s margins, which explains why the self-promoting general merchandise boss, Guy Russo, was keen to get his hands on Target.
Errington noted that “Wesfarmers is also restructuring a number of businesses (Target and Industrial Supply) ... that we believe will negatively impact earnings in the near term materially. Heavy restructuring costs need to be absorbed … and major business disruptions (with heavy loss in staff and management) are likely to cause earnings shortfalls, in our view.”
Errington is very bullish on Wesfarmers rival Woolworths and is backing a revival of its supermarket business against Wesfarmers’ Coles
“We believe the near-term earnings risks surrounding Target are very high … as we understand that parts of the business have turned dysfunctional (post the abrupt exit of management under difficult circumstances). We have a negative view toward the Kmart and Target merger — as we believe a potential lack of trust between the two businesses could be inhibitive,” he added.
Errington is forecasting a 2016 year profit of $2.2bn, down eight per cent from $2.4bn last year with earnings per share to fall from $2.16 a share to $1.98 and dividends to fall from $2 to $1.90 a share.
Errington said that “We see Wesfarmers impairing the asset values of Target and maybe Coal and Industrial Supply. Target has $2.5bn of capital employed, Coal $1.5bn, and Industrial Supply just under $1.5bn … with each not generating the earnings supporting these values.”
Errington also noted that coal losses will be big.
“We estimate the total cost of producing coal at Curragh in FY16 is $140/tonne … which is compared against a realised price of coking coal at Curragh of $ US77/tonne. At an average AUD/USD of 0.87 (including the hedging position of Curragh), we estimate that Curragh is losing (in EBIT/tonne) around $52 per tonne on its 6.5mt produced in FY16 … which is $338m,” Errington said.
Errington has long maintained his opposition to the Target and Kmart merger, a call which is disputed by the company.
Wesfarmers was rocked earlier this year by the leaking of damaging internal pricing policies at Target which were against company policy and led to the ouster of several senior staff, from Target boss Stuart Machin down.
“Closing offices, exiting staff and rehiring could cost many hundreds of millions of dollars … that we expect Wesfarmers to charge to its operating EBIT. And combining this with the likely clearing of Target inventory (much like Big W is currently doing within its business under new management), the losses over the coming 18 months within Target are expected to be very high, in our opinion,” Errington said.