Morgan Stanley has downgraded Wesfarmers

Bunnings. Image: Supplied

Morgan Stanley has downgraded Wesfarmers, Australia’s biggest private employer, saying the market has underestimated the coming impact of Amazon.

Wesfarmers companies Coles and Bunnings have benefitted from strong tailwinds, including the housing boom and a weak Woolworths.

However, those two benefits are fading and Morgan Stanley believes Wesfarmers faces the biggest impact from Amazon’s entry into Australia.

Morgan Stanley now rates Wesfarmers as underweight, down from equal-weight, cutting the price target by 12% to $36 from $41.

Analysts estimate Wesfarmers losing $400 million in EBIT (earnings before interest and taxes) by 2026 as Amazon eats into the market shares of Kmart, Target, Officeworks and Bunnings.

“We continue to think the Australian supermarkets industry is challenged, yet it is still highly profitable by global standards,” writes Morgan Stanley in a note to clients.

“The key change in the past 18 months has been the market leader Woolworths’ focus shifting from maximising margin to profit. Coles as the #2 player is suffering and we expect this to continue.”

Australian supermarkets have seen their market share eroded by new players, including discount chain Aldi. This chart shows the erosion in sales growth:

Morgan Stanley expects a soft launch of Amazon Australia by the end of 2017, with local fulfillment to start during 2018.

“Based on what has happened in other developed counties, we think Amazon will launch (in order), Physical Media, Electronics then Apparel,” the analysts write.

“Categories that are likely to take far longer are Dry Goods, Fresh Food and Auto Parts given the challenged economics of operating the delivery model and higher initial capex required to undertake distribution.

“About 50% of the Australian population lives in just three cities, which makes distribution easier, but addressing lower population densities within cities will prove a challenge.’

Morgan Stanley estimates Amazon will generate $12 billion of sales by 2026.

Wesfarmers generates $22 billion of sales and $2 billion of EBIT from its non-food businesses.

“While Bunnings should be relatively insulated, its department store businesses Kmart and Target ($4.2 billion in sales and $500 billion in EBIT) look particularly vulnerable,” the analysts write.

“We think as Amazon rolls out its 1P business in Australia, especially apparel — which has had huge success in the US — Kmart’s earnings will fall considerably.”

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