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Is Wesfarmers a buy or has its MD had a brain explosion?

Paul Rickard
Thursday, March 28, 2019

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It was a case of “sell first, ask questions later” when the market saw Wesfarmers staggering announcement that it was proposing to acquire rare earth minerals producer Lynas Corporation (ASX: LYC). Wesfarmers share dropped 3.5% on Tuesday, before recovering 0.7% on Wednesday after the Lynas Board ruled out any further engagement.

Summing up the mood of the market, The Australian quoted an unnamed fund manager who said: “if you gave 200 fund managers 200 guesses about what Wesfarmers would buy next, not one of them would have said Lynas”.

And it’s not because Wesfarmers all cash bid of $2.25 per share was pitched at a 44.7% premium to the last closing price of Lynas on the ASX. Most analysts thought this was pretty cheap and a relatively opportunistic bid. But rather, Wesfarmers taking on a business that involves so much political and environmental risk seems like an anathema to a conglomerate that largely operates in relatively defensive sectors. Further, it comes after Wesfarmers has just exited all its mining businesses.

Since taking over 18 months ago, Managing Director Rob Scott has been re-positioning the conglomerate. He has divested Homebase, the chain of UK home improvement stores that Wesfarmers tried to “Bunningise”. He has set the Coles supermarket, convenience store and liquor business free by creating a separately listed ASX entity. For some bizarre reason, Wesfarmers decided to keep a 15% stake in Coles.

Other sales have included:

·      Wesfarmers 40% interest in the Bengalla JV thermal coal mine in the Hunter Valley for $860m. This completed Wesfarmers exit from coal mining (the sale of the Curragh mine was finalised in March 2018);

·      The Kmart Tyre and Autoservice business for $350m; and

·      A 13.2% indirect interest in Quadrant Energy for US$170m.

But as if wanting to lend support to the adage that it is “harder to acquire a business than sell a business”, Scott’s potential foray into rare earth mining is high risk. He has been under pressure to roll out a revenue growth strategy, and it looks like he has succumbed to the pressure to get something moving. Calling it a “brain explosion”, while a little harsh, is not too far off the mark.

On paper at least, Lynas does have the makings of a fantastic business. It is the largest rare earth oxide producer outside of China, sourcing its ore from Mount Weld in Western Australia. From the oxides, Lynas produces neodymium, praseodymium and other heavy minerals that are key ingredients in the permanent magnets used in electric vehicles, energy efficient consumer devices and in the aerospace and defence industries.

After treatment at Mount Weld, the oxides are shipped to the Lynas Advanced Material Plant at Kuantan in Malaysia. And this is where the problem lies, following a ruling by the Malaysian authorities that the company must remove 450 million tonnes of low-level radioactive waste generated by its processing plant. In December, Lynas was forced to temporarily shut down processing at the Kuantan plant after failing to win government approval to increase output. This September, its operating licence is up for renewal.

Wesfarmers says that it can help Lynas as it has “a track record of working well with diverse  Government and other stakeholders to deliver sustainable, positive outcomes for local communities.” And it argues that Lynas could leverage Wesfarmers capabilities in chemical processing.

But in regard to relations with the Malaysian authorities, it is hard to think of too many countries that has been as obstructive to Australian interests as Malaysia has over the last couple of decades.

What do the brokers say?

The brokers see Wesfarmers shares as being marginally overvalued. According to FN Arena, the consensus target price is $32.17, 5.5% lower than yesterday’s closing price of $34.04. Of the major brokers, Citi and Morgan Stanley are the most bearish, with a target price of $29.00, while Macquarie has the highest target price of $37.13. There  are 3 neutral recommendations and 4 sell recommendations, with just one buy recommendation.

None of the major brokers are particularly supportive of the acquisition proposal. While they can see the attraction of a business exposed to the tail winds of electric vehicles and renewable applications, Malaysian political risk is major factor and the acquisition would result in a step-up in the risk profile of Wesfarmers. Following the announcement, Morgans downgraded its recommendation from add to hold.

Bottom line 

Not a buy. If the acquisition goes ahead, which is somewhat unlikely given that the bid is highly conditional and Lynas is refusing to play ball, expect more selling pressure.

Published: Thursday, March 28, 2019


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