There could be an easy way to reverse the underperformance of Wesfarmers Ltd's (ASX: WES) share price.
The struggling conglomerate is likely to get a nice kick in its share price if it spun out its DIY warehouse Bunnings into a separately listed entity, according to a prominent fund manager who was quoted in the Australian Financial Review.
The market cap of a demerged Bunnings could touch $20 billion, or just a little less than half of Wesfarmers' current $46 billion market value, estimates John Sevior from Airlie Funds Management. If this strategy was adopted (and executed well of course), it would almost certainly leave shareholders better off as Bunnings accounts for around a third of Wesfarmers' total group earnings.
Management is reportedly resistant to the idea but may face growing pressure from shareholders if it doesn't come up with a better way to turn around Wesfarmers' poor performance with the stock slumping 5.6% over the past year when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) is up 2.4%.
It's a similar story over a longer term with Wesfarmers' shares advancing 22.3% compared with a 35.3% rally by the top 200 stock index.
Adding insult to injury, the conglomerate's stock is trading at a discount to the market too as it is on a forward price-earnings multiple of 16 times – a 15.8% discount to the industrials sector and an 8.6% discount to the ASX 200.
These figures weaken the argument for keeping the group intact, with management stating it intends to stick with the current structure as breaking it up would have significant costs and potential tax implications for shareholders.
I am unconvinced that either argument justifies poorer returns and would seem a little short-sighted. History has shown that spinning off assets is generally a winning strategy for shareholders with the total value of shares in the parent and child entity trading materially above the value of the original stock pre-demerger.
You only need to look at BHP Billiton Limited (ASX: BHP) cutting the apron strings of South32 Ltd (ASX: S32) for a recent example. The success of the strategy is also what is pressuring BHP to demerge its petroleum assets by hedge fund Elliot Associates.
Wesfarmers' board is likely to face similar pressure from activist shareholders unless it can quickly outline a plan to turn around parts of it businesses – namely discount department store Target and Coles supermarkets.
As for the rationale of keeping the conglomerate together so the stronger businesses can offset the weaker ones, well that also doesn't rest well with me as a shareholder as I feel it gives management something to hide behind when things aren't going as well as they should be. Also, as an investor, I am almost always better off buying several different stocks to hedge my investments.
After all, there is a reason why most conglomerates do not work.
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