Wesfarmers coal sale could impact who may replace CEO Richard Goyder

Wesfarmers would be left with a substantial retail operation spanning Coles, Bunnings, UK-based Homebase, Kmart, Target and Officeworks, but also a rabble of disparate industrial businesses ranging from CSBP fertilisers, industrial safety products, vinyls and investments in domestic gas, softwood plantations and investment bank and funds manager Gresham Partners. The non-retail assets make up less than 10 per cent of it 2017 forecast earnings.

If the earnings from non-retail become so minuscule, is Wesfarmers a retailer rather than the big conglomerate its management espouse?

As one well-regarded investment banker posed to this column, if Wesfarmers returns any sale proceeds back to shareholders rather than make a non-retail acquisition, what does that mean for the choice of a potential replacement for Wesfarmers managing director Richard Goyder, who has been at the helm 11 years.

"The question is do they remain a conglomerate or do they say we've actually got Bunnings, Coles, Target, Kmart and so on and we are a retail business?" the banker said.

"If you are not going to be a conglomerate, and you are a retail business, then it has an impact on who your next CEO may be."

If Wesfarmers is a retailer, perhaps the more logical choice is Bunnings boss John Gillam, the banker noted. If it retains coal or uses sale proceeds to fund a non-retail acquisition, perhaps a better replacement is chief financial officer Terry Bowen or Rob Scott, now in charge of the industrial assets but who has an extensive mergers and acquisitions background.

It's an interesting observation.

There is more runway behind Goyder than in front of him. Fuelling talk he would step down in the short to medium term is speculation he is poised to take over from Mike Fitzpatrick as AFL chairman within the next couple of years.

Goyder for now is sounding out potential buyers for the coal operations, which have been a drag on earnings for the past few years due to weak coal prices.

A spectacular rebound in coal prices – thermal coal has jumped about 80 per cent this year while coking coal has tripled – has substantially improved any potential sale price. Citigroup values the Curragh and Bengalla assets at $2.5 billion.

The last time coal prices were roughly this high (in 2011) Wesfarmers' resources division generated $370 million in earnings in a year impacted by heavy flooding. Last year the coal assets delivered a combined $310 million loss.

One analyst argues that, despite the earnings bounce for coal, Wesfarmers would like to jettison the operations because management are wary of the volatility in the sector. China recently relaxed restrictions on the number of days coal mines could operate to try to dampen prices.

Wesfarmers would be cutting off yet another earnings leg from the metaphorical conglomerate table, which was already a little wonky after the $3 billion exit from the insurance sector during 2013 and 2014.

The non-retail arm posted a loss in 2016, helping drag Wesfarmers to its worst profit in 15 years as coal losses offset $294 million generated by chemicals, energy and fertilisers and $63 million from its industrial product assets.

It's not new for Wesfarmers' earnings to be lopsided. In the 1980s it generated more than 80 per cent of earnings from its fertiliser business CSBP.

In 2009, when its resources arm generated $915 million, 38 per cent of earnings came from non-retail assets.

But now more than 90 per cent of earnings come from its retail operations.

Goyder scoffs at suggestions Wesfarmers isn't really a conglomerate if the vast majority of its earnings come from retail.

He says its retail businesses may be in the same sector but they are very different operations – running hardware for instance is vastly different to managing supermarkets and department stores and vice-versa.

So they operate independently, with independent boards, reporting to the lean head office.

So, perhaps Wesfarmers will simply be a diversified retailer?

Back in 2014 investors urged Wesfarmers to use the spoils of its insurance sale to make a meaty acquisition that could generate fresh revenue streams.

Instead, Wesfarmers gave shareholders $1.1 billion via a capital return in 2014.

It's also done some deals – three out of four outside of retail. They are the $70 million Mineral Development Licence 162, the $180 million purchase of clothing maker Workwear Group and grabbing a 13.5 per cent stake in domestic gas producer Quadrant Energy for $US100 million last year.

But the biggest was in retail with this year's $705 million acquisition of UK hardware chain Homebase, Wesfarmers' first offshore deal in its 102-year history.

Perhaps adding weight to the argument that Wesfarmers should start to flex its conglomerate muscle and find another earnings leg – away from retail - is that its retail operations are becoming increasingly challenged.

A resurgent Woolworths, the expansion of Aldi and Costco and the looming threat of Amazon – which is rumoured to be putting distribution centres in every state to underpin a sales strategy on general merchandise and fresh food – make the outlook for Wesfarmers' supermarket and department stores far more challenging.

Merrill Lynch analyst David Errington has taken Goyder to task this year over the company's returns. He is upset they didn't jettison coal sooner, allowing them to benefit fully from the retail assets that now face challenges.

"Wesfarmers always opens up its statements, or its strategy day, that your mission is to generate acceptable returns to shareholders," Errington told Goyder at Wesfarmers investor day in June.

"When you listen to Caltex and companies like Amcor, they give a very defined target. They want to be in the top quartile in terms of total shareholder returns. Wesfarmers in the last five years has been in the third quartile or thereabouts through various factors."

A total shareholder return ranking of Australia's 50 biggest companies recently compiled by Wesfarmers shows the company came in at number 17 on a one-year basis, 27 on a three-year basis, 30 on a five-year basis but ranked 13 when taking a decade view (just outside of the top quartile).

The top performer over five and 10 years was Ramsay Healthcare. Qantas Airways secured top spot over a three-year period.

Goyder for his part cops the criticism on the chin.

He agrees Wesfarmers should be doing better. Doing that involves improving Target and sorting out coal.

He wants Wesfarmers to be in the top quartile for TSRs. But he also makes the point that doing that is much harder "the bigger you get".

Goyder says Wesfarmers hasn't had the luxury of the "reset" button – where a new chief executive comes in, cleans out the cupboard and resets the earnings base. He says it doesn't get the bump pure-play resources companies enjoy when commodity prices bounce off lows (although there is an argument it is benefiting plenty with coal).

"It is hard for us to constantly outperform based on short periods," he says.

That's why Goyder says the focus should always be on shareholder growth over the long term.

The market, however, remains to be convinced. About 30 per cent of analysts tracked by Bloomberg recommend buying the stock. About 40 per cent say hold, while the remaining 30 per cent, such as Citi analyst Craig Woolford, recommend selling.

Woolford argues the potential coal sale (his valuation is $2.5 billion) is not material enough to change his negative view on the company. In other words, the risk to Coles earnings are far greater a concern.