E-commerce Decline And Margin Squeeze Will Hinder Growth Despite Digitization

Key Takeaways

• Rising digital disruption and demographic shifts threaten to reduce retail revenues and limit long-term growth across Wesfarmers' core businesses.
  
• Sustained investment needs and intense competition are set to pressure margins, cash flow, and overall profitability, with international diversification efforts offering limited near-term relief.
  
• Investment in digital transformation, sector diversification, and customer engagement positions Wesfarmers for long-term growth, earnings resilience, and increased operational flexibility.

Catalysts

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

• Accelerating e-commerce adoption and increased digital disruption are likely to further erode brick-and-mortar retail foot traffic, putting sustained long-term pressure on revenues and reducing the operating leverage of Wesfarmers' physical retail formats despite their investments in digital channels.
  
• Persistent demographic headwinds such as an aging population and projected slowdown in Australian consumer spending threaten to structurally limit demand growth for core divisions like Bunnings, Kmart, and Officeworks, leading to a lower revenue growth profile for the group over the next decade.
  
• Heavy ongoing capital expenditure and operating expenses required for digital transformation, store refurbishments, and ESG compliance are set to weigh on free cash flow and dilute future net earnings, especially as much of digital investment is running through operating expenses rather than being capitalized.
  
• Exposure to significant margin compression risks from intensifying discounting and promotional activity in retail and the entrance of global digital-native players such as Amazon will force Wesfarmers to continue sacrificing gross margins to maintain competitiveness, undermining long-term profitability.
  
• Overdependence on the Australian market and domestic consumption leaves Wesfarmers highly vulnerable to local economic downturns, and the group's earnings will face increased cyclicality as international expansion efforts in segments like Anko and lithium remain unproven and unlikely to materially offset domestic downturns in the near-to-medium term.

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 4.4% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 5.8% 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$3.01) by about August 2028, up from A$2.6 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 24.3x on those 2028 earnings, down from 40.4x today. This future PE is lower than the current PE for the AU Multiline Retail industry at 43.9x.
• 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 8.04%, as per the Simply Wall St company report.

Wesfarmers Future Earnings Per Share Growth

Risks

• Ongoing investments in productivity, efficiency, and digitization across Wesfarmers' divisions, including integrating Target and Kmart operations, rollout of omnichannel platforms, and new fulfillment centers, are driving sustainable cost savings and margin expansion, which may support long-term earnings growth.
  
• Strong demographic trends such as population growth, urbanization, and full employment in Australia continue to underpin stable demand for Wesfarmers' key retail businesses like Bunnings, Kmart, and Officeworks, providing sustained revenue growth potential.
  
• Strategic expansion into growth sectors such as health care and lithium, including the Covalent Lithium JV and Priceline/InstantScripts acquisitions, opens new and potentially resilient revenue streams that can offset cyclicality in traditional businesses and support earnings diversification.
  
• A robust balance sheet with declining net financial debt and significant debt headroom provides Wesfarmers with flexibility to invest in organic growth, pursue acquisitions, and weather economic downturns, helping to protect and enhance future net profits.
  
• The company's ability to leverage data analytics, loyalty programs like OnePass, and the emerging retail media network, together with a curated marketplace approach, gives it new avenues for incremental revenue and margin improvement, particularly through better customer engagement and higher sales per customer.

Valuation

• The assumed bearish price target for Wesfarmers is A$58.0, which represents the lowest price target estimate amongst analysts. 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$90.3, 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$51.2 billion, earnings will come to A$3.4 billion, and it would be trading on a PE ratio of 24.3x, assuming you use a discount rate of 8.0%.
• Given the current share price of A$92.47, the bearish analyst price target of A$58.0 is 59.4% 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.