Wesfarmers Stock Analysis and Recommendation

This assignment tasks the student with analyzing Wesfarmers' financial performance based on provided data. Key areas of focus include the debt ratio and gearing ratio, as well as the company's dividend policy. The student is expected to interpret this data and provide a recommendation regarding the inclusion of Wesfarmers stock in an investment portfolio.

Running head: FINANCE FOR BUSINESS - MASTERS
Finance for business - Masters
Name of the student
Name of the University
Author note

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Table of Contents
1. Company description..........................................................................................................2
2. Ownership – governance structure.....................................................................................2
3. Key ratios............................................................................................................................3
4. Information from the website of ASX................................................................................4
5. Recent announcement.........................................................................................................5
6. Stock field...........................................................................................................................6
7. WACC................................................................................................................................6
8. Optimal structure for debt...................................................................................................7
9. Dividend policy...................................................................................................................8
10. Recommendation................................................................................................................8
Reference....................................................................................................................................9

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1. Company description
Wesfarmers is the leading listed company in Australia that is focussed on the diverse
operation for providing satisfactory returns to the shareholders. It is engaged in the
production, retailing, coal mining, gas distribution and processing, distribution of safety and
industrial products, manufacturing of fertilizers and chemicals and the investment business all
over Australia, United Kingdom, New Zealand and various other countries. Wesfarmers
operates 702 convenience outlets, 83 liquor stores, 89 hotels and 801 Coles supermarkets
(Wesfarmers 2017).
2. Ownership – governance structure
i. Name of substantial ownership
 Holding more than 20% shares – HSBC Custody Niminees (Australia) Limited is
holding 21.25% of total shares of the company.
 Holding more than 5% shares – J P Morgan Nominees Australia Limited is holding
12.29% shares and Citicorp Nominees Pty Limited is holding 5.77% shares of the
company.
ii. Name of key personnel
 Chairman – Michael Chaney AO
 Board members – apart from Chairman and CEO, other board members are -
 Terry Bowen, Finance Director
 Jennifer Westacott, Director
 Vanessa Wallace, Director
 Wayne Osborn, Director
 Paul Bassat, Director
 Tony Howarth AO, director

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 Diane Smith – Gander, Director
 James Graham AM, Director
 CEO – Richard Goyder AO
 Any of the key personnel of Wesfarmers does not hold more than 5% or more than
20% of the company’s shares and therefore does not included in the list of substantial
shareholders.
3. Key ratios
i. Return on assets (ROA) = (NPAT / Total Assets)
Return on Equity (ROE) = (Net profit after tax / Ordinary equity)
Debt ratio = Total liabilities / Total assets
Ratio Formula 2017 2016 2015 2014
Return on assets NAPT / Total asset 0.072 0.010 0.060 0.038
Return on equity NPAT / Ordinary equity 0.120 0.018 0.098 0.058
Debt ratio Total liab / Total assets 0.403 0.437 0.387 0.346
EBIT/TA * NPAT/EBIT * TA/OE = NPAT/OE
EBIT/TA * NPAT/EBIT * TA/OE = 4,402/40,115 * 2,873/4,402 * 40,115/23,941
= 0.120
NPAT/OE = 2,873/23,941 = 0.120
Therefore, EBIT/TA * NPAT/EBIT * TA/OE = NPAT/OE
ii. phenomenon of the variable TA/OE
TA stands for total assets and OE stands for ordinary equity or owner’s equity.
TA/OE signifies the total assets of the company as compared to the equity of the company
(Halili, Saleh and Zeitun 2015). It represents the company’s insolvency risk and measures the

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shareholder’s exposures against the company’s total asset. If the company’s equity goes up
the return on equity of the company will reduce.
iii. Reasons behind ROE being greater than ROA
ROE and ROA both are the measure for measuring the return performance of the
company. If the total asset of the company is higher than the shareholder’s equity, the ROE
will be higher than ROA (He and Krishnamurthy 2013).
4. Information from the website of ASX
i. Movement graph of monthly stock for last 2 years
Wesfarmers Limited
01/12/2015
01/02/2016
01/04/2016
01/06/2016
01/08/2016
01/10/2016
01/12/2016
01/02/2017
01/04/2017
01/06/2017
01/08/2017
01/10/2017
0
5
10
15
20
25
30
35
40
45
50
Wesfarmers Limited
Adj Close

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All Ordinary Index
01/12/2015
01/02/2016
01/04/2016
01/06/2016
01/08/2016
01/10/2016
01/12/2016
01/02/2017
01/04/2017
01/06/2017
01/08/2017
01/10/2017
0
1000
2000
3000
4000
5000
6000
7000
All Ordinary Index
Adj Close
ii. Stock movement report
From the above graphs of Wesfarmers stock and All Ords Index, it is recognized that
both the stocks are upward moving. However, the stock of Wesfarmers is more fluctuating as
against the stock of All Ords Index. Therefore, the stock of Wesfarmers is more volatile.
Further, the correlation computed between 2 firms resulted as 0.862. Therefore, the stocks are
uncorrelated.
5. Recent announcement
 On 22nd December 2017, the company announced to sell Curragh coal mine for $ 700
million
 During July 2017 the company announced that it will phase out the single use plastic
bags from all the stores
 For recognizing long-term relationship the company announced expanded partnership
with WASO that will focus on international and regional touring
 During May 2017, the company announced appointments of 3 senior executives as
transition part of the group leadership

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6. Stock field
i. Beta of Wesfarmers is 1.02
ii. Risk free rate = Rf = 4%, market risk premium = Rm = 6%
Therefore, required rate of return of the company’s share =
R = Rf + β ( Rm – Rf )
R = 4% + 1.02* (6% – 4%) = 6.04%
iii. Conservative investment
Conservative investment is the investment approach where the value of investment is
protected through investing in the lower risk associated and regular income paying stock. As
the beta of the company is only 1.02 it is considered to be a stock with lower risk (Harris and
Mazibas 2013). Further, the company is regular with regard to the payment of dividend.
Therefore, stock of Wesfarmers can be considered as conservative investment.
7. WACC
i. Computation of WACC
WACC = E/V * Re +D/V * Rd * (1-Tc), Where,
i. E/V = Equity percentage in capital structure = 81%
ii. D/V = Debt percentage in capital structure = 19%
iii. Re = Cost of equity = 6.04%
iv. Rd = Rate of debt = 5.25%
v. Tc = corporate tax rate = 30%
Therefore, WACC = 81*6.04% + 19*5.25% (1-0.30)

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= 4.89 + 0.70 = 5.59%
ii. Implication of higher WACC on management evaluation
The higher WACC indicates that the capital risk of the company is higher and the
management shall raise the fund from lower cost sources. Further, the company shall find
profitable project that is associated with lower risk (Zabarankin, Pavlikov and Uryasev 2014).
Whether the fund is raised through equity or debt it raised in exchange of cost like interest
risk or dividend or share of profit. Therefore, before raising additional fund the company
shall take into consideration the WACC of the company and find out most appropriate source
for the company.
8. Optimal structure for debt
i. Optimal capital structure
Debt ratio Total liabilities / Total assets Year 2017 = 0.404 Year 2016 = 0.437
The ratio at which the value of the company is maximised is known as the optimum
capital structure. The debt cost is considered as low as compared to cost of equity as the debt
are deductible under tax and the equities are not deductible (Albul, Jaffee and Tchistyi 2015).
Generally, 0.4 or lower than that is considered as appropriate debt structure if the pure risk
aspect is considered. Looking into the debt ratio of the company, it is recognized that the debt
ratio of the company for 2016 is 0.437 and for 2017 is 0.404. Therefore, the debt ratio of the
company is ideal and stable.
ii. Gearing ratio
For adjusting the gearing ratio the company reduced their borrowing from $ 5.671
million to $ 4,066 million from 2016 to 2017. Further, the company issued 2,378 shares for $

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93 million (Renneboog and Szilagyi 2015). However, the directors did not mention anything
related to the adjustments in their report.
9. Dividend policy
The dividend policy of Wesfarmers considers the generation of free cash flow,
availability of franking credits, generation of profit and assures to deliver the growing
dividends over the time (Zhang 2014).
10. Recommendation
From the above analysis it is recommended that the stock of Wesfarmers shall be
included in the portfolio of the client for investment. The reason behind this is that the beta of
the company is 1.02 that states the stock of the company is exposed to lower risk. Further, the
company is regular in paying dividend. Therefore, the stock can be considered as regular
source of income. Therefore, it meets the preferred criteria of any investor and therefore shall
be included in the portfolio of the client.

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Reference
Albul, B., Jaffee, D.M. and Tchistyi, A., 2015. Contingent convertible bonds and capital
structure decisions.
Halili, E, Saleh, A and Zeitun, R., 2015. 'Governance and Long-Term Operating Performance of
Family and Non-Family Firms in Australia', Studies in Economics and Finance, vol.32, no.4,
pp.398-421.
Harris, R.D. and Mazibas, M., 2013. Dynamic hedge fund portfolio construction: A semi-
parametric approach. Journal of Banking & Finance, 37(1), pp.139-149.
He, Z. and Krishnamurthy, A., 2013. Intermediary asset pricing. The American Economic
Review, 103(2), pp.732-770.
Renneboog, L. and Szilagyi, P.G., 2015. How relevant is dividend policy under low
shareholder protection?. Journal of International Financial Markets, Institutions and Money.
Wesfarmers., 2017. Home - Wesfarmers. [online] Available at: http://wesfarmers.com.au/
[Accessed 18 Jan. 2018].
Zabarankin, M., Pavlikov, K. and Uryasev, S., 2014. Capital asset pricing model (CAPM)
with drawdown measure. European Journal of Operational Research, 234(2), pp.508-517.
Zhang, Z., 2014. On a risk model with randomized dividend-decision times. Journal of
Industrial & Management Optimization, 10(4), pp.1041-1058.