Conglomerates tend to trade at a discount to their sum-of-parts valuation. Some companies try to unlock value for shareholders by demerging assets. Amcor Limited (ASX: AMC) spinning off its packaging and distribution assets into Orora Ltd (ASX: ORA) is a successful example of this.
There are two reasons why conglomerates tend to trade at a discount to their sum-of-parts valuation.
The first reason is that management can be stretched too thin trying to manage several unrelated assets, causing the individual assets to be mismanaged and therefore not performing as well as they should.
The second reason is the lack of transparency regarding performance of individual assets in a conglomerate. Although companies are required to report performance by segment, this is usually done at a very high and generic level. This creates uncertainty which the market views as higher risk, therefore discounting the value of the assets to below their intrinsic value.
With this in mind and the fact that Wesfarmers Ltd (ASX: WSX) has fallen over 9% since early November, is it undervalued?
One way to quantify this is to use the Price-to-Sales (P/S) ratio as the valuation metric for each asset owned by Wesfarmers, and then use a range of domestic and international peers as comparisons.
Based on FY14 financials the company will have four distinct assets going forward – Supermarkets, Home Improvement, Discount department stores and Industrials. Since the Industrials division comprises three distinct assets, the analysis is broken up into six sections. Applying the peer P/S ratio to each asset, the market capitalisation for Wesfarmers should be $48.5 billion – nearly 5% above its current market value.
It needs to be pointed out that Woolworths Limited was used as the comparison for the Supermarket division. Same-Store-Sales growth by Coles supermarkets has been higher than Woolworths for 21 consecutive quarters, so there's reason to believe that Wesfarmers is actually even more undervalued.
Buy, Hold, or Sell?
Although Wesfarmers is undervalued per above I would advocate for a larger margin of safety before jumping in. Further this hidden value will only be unlocked if the company chooses to demerge – this appears unlikely in the near future since there has been no news flow on this.
