Lonsec   ⟩   News & Insights   ⟩   Media releases   ⟩   The death of the conglomerate
Gordon Toy

AuthorGordon Toy

DateApril 19, 2018

CategoryMedia releases

Share

Wesfarmers (ASX: WES) surprised the market in March 2018 by announcing its intention to demerge the Coles supermarket business from its portfolio. This reverses the original decision made in July 2007 to acquire Coles for $22 billion in what was then the largest takeover in Australia. For many years, WES was a shining example of a successful and large-scale conglomerate model. With the demerger of Coles, Lonsec questions whether the market is calling time on such structures.

WES shareprice

Source: Lonsec, Bloomberg

Lonsec notes that WES’s original ‘profit improvement plan’ in 2007 has largely worked, with the resulting 9.5% EBIT CAGR for Coles since 2009 having extracted maximum valuation upside for WES and allowing it now to cash in on its original investment. But if WES’s intention was always to sell, it begs the question why it was willing to pay a substantial premium (10%) over Coles’ prevailing share price at the time. As the chart below shows, WES has underperformed both the S&P/ASX 200 Index as well as the S&P/ASX 50 Index, with Coles proving to be a drag on overall growth.

WES performance versus ASX

Source: Lonsec, Bloomberg

For a rationally managed conglomerate, the marginal capital dollar should be allocated to the highest returning assets. In the case of WES, this would mean allocating capital to Bunnings locally or Kmart. Instead, capital was disproportionately allocated to the capital hungry Coles, more to defend its market position than to fund organic growth. This misallocation meant that the market justifiably had an issue with applying a ‘sum-of-the-parts’ valuation, in effect trapping shareholder value in the conglomerate structure. This is partly the reason why Lonsec’s growth outlook for WES has been low (see chart below).

WES growth conundrum

Source: Lonsec, Wesfarmers

Demergers have been in vogue on the ASX of late, with other contemporary examples including Fairfax’s demerger of Domain and the demerger of the old BHP Billiton into separate vehicles holding the BHP and Billiton (or S32) assets. Lonsec believes that a demerger trend could be beneficial for shareholders in cases where the conglomerate model is failing to provide a balanced and diversified portfolio.

Release ends

IMPORTANT NOTICE: This document is published by Lonsec Research Pty Ltd ABN 11 151 658 561, AFSL 421 445 (Lonsec).

Please read the following before making any investment decision about any financial product mentioned in this document.

Warnings: Lonsec reserves the right to withdraw this document at any time and assumes no obligation to update this document after the date of publication. Past performance is not a reliable indicator of future performance. Any express or implied recommendation, rating, or advice presented in this document is a “class service” (as defined in the Financial Advisers Act 2008 (NZ)) or limited to “general advice” (as defined in the Corporations Act (C’th)) and based solely on consideration of data or the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person.

Warnings and Disclosure in relation to particular products: If our general advice relates to the acquisition or possible acquisition or disposal or possible disposal of particular classes of assets or financial product(s), before making any decision the reader should obtain and consider more information, including the Investment Statement or Product Disclosure Statement and, where relevant, refer to Lonsec’s full research report for each financial product, including the disclosure notice. The reader must also consider whether it is personally appropriate in light of his or her financial circumstances or should seek further advice on its appropriateness. It is not a “personalised service” (as defined in the Financial Advisers Act 2008 (NZ)) and does not constitute a recommendation to purchase, hold, redeem or sell any financial product(s), and the reader should seek independent financial advice before investing in any financial product. Lonsec may receive a fee from Fund Manager or Product Issuer (s) for reviewing and rating individual financial product(s), using comprehensive and objective criteria. Lonsec may also receive fees from the Fund Manager or Financial Product Issuer (s) for subscribing to investment research content and services provided by Lonsec.

Disclaimer: This document is for the exclusive use of the person to whom it is provided by Lonsec and must not be used or relied upon by any other person. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by Lonsec. Conclusions, ratings and advice are reasonably held at the time of completion but subject to change without notice. Lonsec assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, Lonsec, its directors, officers, employees and agents disclaim all liability for any error, inaccuracy, misstatement or omission, or any loss suffered through relying on the information.

Copyright © 2018 Lonsec Research Pty Ltd, ABN 11 151 658 561 AFSL 421 445. All rights reserved. Read our Privacy Policy here.

For more information contact:

Gordon Toy
03 9623 6373
Gordon.Toy@lonsec.com.au

Related stories

15 Nov 2018 - Leading research and investment solutions house Lonsec has appointed Rob Hardy to the newly created role of Executive Director of Sales and Marketing. Mr ...

Lonsec appoints new Executive Director of Sales and Marketing

By Gordon Toy Read now

15 Nov 2018 - Financial advisers are now able to access investment research, encompassing clients’ whole of life needs, with the announcement by Lonsec of the inclusion of ...

Understanding super no longer optional for advisers

By Gordon Toy Read now

12 Sep 2018 - Exchange Traded Funds (ETFs) have become a popular way for investors to gain exposure not only to passive indices but to a range of market factors. Smart ...

Not all income is created equal

By Gordon Toy Read now