Digital Disruption And Cost Hikes Will Choke Retail Margins

Key Takeaways

• Sustained digital disruption, sustainability demands, and rising labor costs challenge profitability and require major ongoing investment in technology and responsible practices.
  
• Heavy dependence on Bunnings and Kmart/Target, along with mounting global competition, threatens revenue stability and long-term growth resilience.
  
• Strong brand portfolio, strategic diversification, and ongoing efficiency initiatives are driving stable growth, margin resilience, and a robust platform for new long-term opportunities.

Catalysts

Engages in the retail business in Australia, New Zealand, and internationally.

• Persistent digital disruption and the acceleration of e-commerce are likely to continue eroding store traffic and market share in Wesfarmers' core retail businesses, requiring disproportionately high investment in omnichannel capabilities; this will put downward pressure on revenue growth and increase capital and operating expenditures, limiting long-term earnings expansion.
  
• Rising consumer demand for environmental and social responsibility, combined with increasingly stringent regulatory requirements, will force Wesfarmers to invest heavily in costly sustainability initiatives and product transitions; failure to keep pace or unsuccessful execution could result in compressed net margins and exposure to reputational and compliance risks.
  
• Heavy reliance on Bunnings and Kmart/Target for the majority of group revenue means that any underperformance or saturation in these divisions, especially if home improvement demand weakens or discount retail faces heightened competition, could lead to stagnating top-line growth and reduced resilience of group earnings.
  
• Intensifying competition from international retailers like Amazon and Aldi will drive ongoing price wars and compress sector-wide margins, making it difficult for Wesfarmers' brands to sustain premium positioning or market share, ultimately reducing profitability.
  
• Higher wage pressures, workforce automation costs, and ongoing supply chain complexity are set to increase both labor and capital costs for Wesfarmers' retail operations, affecting operational efficiency and driving persistent cost of doing business inflation, which is likely to negatively impact gross margins and net profit over time.

Wesfarmers Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Wesfarmers compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Wesfarmers's revenue will grow by 3.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 6.4% today to 6.7% in 3 years time.
• The bearish analysts expect earnings to reach A$3.4 billion (and earnings per share of A$3.0) by about September 2028, up from A$2.9 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 24.9x on those 2028 earnings, down from 36.0x today. This future PE is lower than the current PE for the AU Multiline Retail industry at 35.8x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.08%, as per the Simply Wall St company report.

Wesfarmers Future Earnings Per Share Growth

Risks

• The group's leading retail brands, Bunnings, Kmart, Officeworks, and Priceline, continue to benefit from demographic tailwinds such as population growth and urbanization in Australia, supporting robust demand for home improvement and consumer staples, which is likely to underpin sustained revenue and earnings growth.
  
• Ongoing investments in omnichannel retail, digital transformation, and supply chain optimization across all divisions are delivering cost efficiencies and supporting margin resilience, positioning Wesfarmers to capture greater wallet share and drive higher net margins in the long term.
  
• Wesfarmers is actively expanding into new market segments such as healthcare and pharmaceuticals, with Priceline Pharmacy showing strong comparable store growth and expanding its network, which enhances earnings diversification and opens new profit streams for the group.
  
• The company's balance sheet remains strong with a low net debt-to-EBITDA ratio, high free cash flow generation, and substantial funding headroom, providing flexibility to invest in further growth opportunities, manage risks, and support shareholder distributions-all of which support long-term shareholder value.
  
• Strategic initiatives such as the ramp up of the Covalent lithium business, sustainability investments including 100% renewable energy targets in key divisions, and the launch of growth platforms like Anko Global and retail media further diversify earnings and create new long-term revenue opportunities for the group.

Valuation

• The assumed bearish price target for Wesfarmers is A$59.41, which represents two standard deviations below the consensus price target of A$80.76. This valuation is based on what can be assumed as the expectations of Wesfarmers's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$100.0, and the most bearish reporting a price target of just A$58.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be A$50.6 billion, earnings will come to A$3.4 billion, and it would be trading on a PE ratio of 24.9x, assuming you use a discount rate of 8.1%.
• Given the current share price of A$92.84, the bearish analyst price target of A$59.41 is 56.3% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.