8 September 2021

Is Wesfarmers Australia’s Answer to Warren Buffet’s Berkshire Hathaway?

Wesfarmers was founded in 1914 as a small West Australian farmers’ cooperative. Today it is Australia’s seventh largest listed company with a market capitalisation of $70 billion and an array of profitable businesses, of which the Bunnings hardware chain is the largest. It has cast off Coles which is now owned separately although Wesfarmers still owns 5.1percent of Coles shares. Looked at in terms of revenue the following table indicates the relative size of Wesfarmers owned businesses.

Business / 2021 Revenue millions / % of Overall Wesfarmers Sales

Bunnings              $16,861   49.7

K Mart                       6,791   20.0

Office Works            3,014   8.9

Target                        2,592   7.6

Wesfarmers Chem. 2,146   6.3

Industrial Safet       1,855   5.5

Catch                             673   1.9

                                  $33,941 Million 100%

Other Investments

These include residual 4.9 percent of Coles Group following a sell down of 10.1 percent, plus 24.8 percent of Bunnings Warehouse trust. 

Lithium

Wesfarmers Chemical Energy and Fertilisers also includes spending on long lead items for construction of the Mt Holland Lithium project. 

Proposed Capital Return

Subject to approval at annual general meeting it is intended to return $2.3 billion of surplus capital to shareholders. 

Proposal to Buy Australian Pharmaceutical Industries (API). 

Wesfarmers recently made an offer to purchase API which was rejected by API’s board. It is normal with takeovers for a company’s offer to be below the price it is prepared to pay. We await further developments. 

Overall View of Wesfarmers

 Wesfarmers is a successful conglomerate with a history of outstanding management. While it has made an occasional mistake—notably its attempt to enter the UK hardware market—it has enjoyed huge success, particularly in its growth of Bunnings demonstrated by its success in beating off the Woolworths Masters hardware venture. It continues to develop Bunnings with new warehouse stores and additional product ranges. It has dealt with the troubled Target business acquired with Coles through closure of some stores, converting others to K Marts and revitalising the remainder. Wesfarmers chemical, energy and fertilisers will also house its Mt Holland Lithium project. It should be remembered that it previously owned a successful coal mining venture which it sold in a timely manner.

 Wesfarmers shareholders have enjoyed 10.5 percent compound annual growth over the past 10 years to which must be added dividends which amount to a dividend yield of 2.75 percent fully franked in the last year. 

I regard Wesfarmers as a reliable stock to own in our super fund. It is likely to provide steady performance but will not provide spectacular rates of growth as most of its businesses are relatively mature.

Buying High Rise Rental Apartments off the Plan is Dangerous Financially 

Developers commit a significant slice of their budget to marketing costs. The onsite sales offices, ever so polite salesmen on high commissions, fancy brochures, online advertising, fancy models and carefully crafted presentations do not come cheaply. Those who put down a 10 percent deposit on a binding contract with a bank to finance the eventual settlement are often shocked when the valuation at settlement required by their bank is frequently well short of the contracted purchase price requiring them to find more cash to put in.

Prospective income statements from property rental often overstate rents and understate landlord ownership expenses. The net income before factoring in interest and borrowing costs is typically very low, often around 2 percent or less. Since investors can get more return than that on listed real estate investment trusts with less stress it demands the question why invest in residential rental property, particularly high-rise units?  It is even worse in Queensland where local law enables developers to sell off long term management rights separately to the units.

You cannot add an extension to an apartment or do significant modifications.

Over the years on meeting many clients for the first time I found that they had invested in rental apartments and heartily wished that they had not. They were invariably happy to sell them when the facts of their abysmal returns taken from their tax returns were pointed out.  The ownership of rental apartments is heavily concentrated among those with secure government jobs including teachers, public servants, and police because banks list them as safe borrowers and they follow their work colleagues.

For most dentists and veterinarians their two best investments are usually their homes and their practice premises. The latter may not be the case in smaller country centres.

Those who build up strong equity portfolios, usually inside their SMSFs, have far fewer worries than those who bought apartments off the plan and over the long term achieve far better results.

By way of comparison check out the net yields on a range of listed property funds/REITs. 

Buffett on Fixed Interest Investment

In his 27 Feb 2021 report to Berkshire Hathaway shareholders legendary investor Warren Buffett said:

“...bonds are not the place to be these days. Can you believe that the income recently available from a 10-year US Treasury bond- the yield was 0.93% at year end – had fallen by 94 percent from the 15.8% yield available in September 1981? In certain large and important countries, such as Germany and Japan, investors earn a negative return on trillions of dollars of sovereign debt. Fixed -income investors world- wide – whether pension funds, insurance companies or retirees – face a bleak future.”

The True Cost of Dental Practice Managers 

A dental practice manager, other than a courtesy title given to a receptionist, is far more costly than many dentists realise! For a true understanding of their cost in both lost income and lowered capital value of a dental practice my book “Financial Success for Dentists” will be essential reading. To obtain your copy see below.

Small Businesses are Relationship Driven, Big Businesses are Driven by Capital Investment 

 The local restaurant, coffee shop, pharmacist, dentist, and vet all realise that to survive and thrive in business they must cultivate strong interpersonal relationship bonds with their customers. The value in their practices and businesses is the loyalty of their customers. If a new dental practice is started by a dentist not locally known and there is an existing established practice with a large patient list the existing practice continues to treat its patient list and these patients continue to refer their friends and relatives to the existing practice while the new practice remains unknown and can only grow slowly. Not surprisingly a lot of new practices having invested heavily in fit out and equipment fail to generate sufficient patient fees to cover expenses and disappear almost unnoticed.

Big businesses are impersonal. Coles and Woolworths have largely automated checkouts thus completing a process of depersonalisation but have huge investments in stores stock on hand warehousing and supply chain management.

The days are long gone when small miners succeed by mining with pick and shovel technology. Now ever larger machines and increasing technology are required which require the capital aggregation of massive businesses. Like supermarket chains these are large impersonal corporations. 

I have been provided with many examples of small animal veterinary practices which have had substantial influxes of new patients when a large practice nearby has been purchased by a corporate. The three-way relationship between vets, pet owners and pets consistently triumphs over the corporate nearby. It is likely that the best place for a couple of vets to open their own practice is near a large corporate practice if they can find a site and are prepared to work long hours to establish themselves. However most dental practice start-ups remain high risk and practice start-ups inside shopping centres are subject to huge rents and may prove unsaleable long term.

Practice Ownership Structure

Veterinary practice owners have partnerships, but associateships are preferable for dental practice ownership. Their successful business models are very different. 

Superannuation Turning Australia into an International Investing Nation

The Hawke Government was elected in 1983 and quickly began reforming the Australian economy. Hawke recognised that too much income was going to wages and not enough for business investment and at the same time our terms of trade were poor. The solution adopted was a national superannuation plan which was sold to the unions as saving for workers retirement. The underlying reasons were related to Australia’s foreign debt situation. The superannuation guarantee which started at 4 percent of wages (3 percent for small businesses) has crept up to 10 percent with 12 percent the eventual target. The superannuation system now has over $3 trillion and growing, with 40 percent of that invested overseas. A lot of large Australian companies have substantial international business arms. 

Vastly Different Dental Corporate Outcomes

1300 Smiles recently announced its sale at a huge price for an enterprise consisting of 33 dental practices. It was the first of the Australian dental corporates and built carefully. The odd mistake was dealt with and did not contaminate the group. Smiles Inclusive was a roll up of over 50 practices and had a short disastrous corporate life, never declaring a profit or a dividend and resorting to a series of desperate measures to remain afloat. After a short time as an ASX listed business, Smiles Inclusive failed to produce timely audited financials and trading of shares was suspended. Its last desperate attempt to raise more equity was thwarted by the corporate regulator because of its inability to meet regulatory requirements. It was then placed into administration from whence it passed into liquidation.

A significant number of Australian corporatized professional services businesses have failed over the last 20 years and such ventures are a great deal riskier than their promoters admit.

For an understanding of the pitfalls which can occur read “ The Rise and Fall of Megadent ” in Financial Success For Dentist.

To obtain a copy:

Go to the Delany Foundation website at http://www.delanyfoundation.org.au

Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.

Email financialsuccessfordentists@gmail.com confirming that your donation has been made, as well as your name and mail address.

A copy of the book will be mailed directly to you.

All production costs and mail costs are met by me personally, so all money donated goes to the Delany Foundation which contributes toward the running of schools in Ghana, Kenya and Papua New Guinea. Naturally donations above $60 are welcome.

The donation to obtain this publication will be the most cost-effective practice advice most dentists will ever receive.

A complete and comprehensive career guide for mature and aspiring dentists.

Based on real life situations and a lifetime of dealing with dental practice ownership outcomes this book is worthy of Text Book status for every dental teaching school.

—Merv Saultry, Founder Dental Innovations Network

Financial Success for Dentists: Rules for How to Approach Your Dental Career sets out the key strategies which make dentists successful. It is specifically written for those dentists and dental specialists owing their own practices and for those aspiring to own practices. Among the topics included:

·      Understand key practice valuation criteria.

·      Learn how some dentists inadvertently reduce the value of their practice by $500,000

·      Avoid long term errors when purchasing your practice.

There are many accountants, financial advisers, marketing consultants, web site designers and practice advisers who give advice from their particular disciplinary experience, but very few have the wider breadth of experience to define for their clients the key rules to follow to optimize their practice and their long-term financial outcomes. An otherwise competent financial adviser may have little understanding of what makes one practice much more successful than another. Many accountants have detailed knowledge of the taxation rules but cannot identify if a dental client has broached invisible barriers to practice growth or a threat to practice goodwill value. 

I spent 33 years examining dental practice financial outcomes and reviewing the key strategies and decisions which separated successful Australian dental practices and practice owners from the less successful and this led to relevant conclusions and advice to dental practice owners.  

General Advice

 Advice on investments is general advice and readers must do additional research of their own accessing broker reports and taking professional advice as necessary. All investors must have a deep knowledge of individual company financial performance, business strategy and economic risk. Investment decisions must also relate to individual circumstances including net assets, annual income and years to retirement.

I sold my interest in a financial services and accounting group on 30 June 2020 and have no intention of starting another financial services business. I own, via my family superannuation fund and investment portfolio, some of the stocks mentioned in this newsletter. Those who find my newsletters of value to them are asked to consider making a donation to the Delany Foundation, a registered charity which assists schools in Papua New Guinea, Ghana and Kenya. Delany Foundation c/- Holy Cross College, 517 Victoria Road Ryde NSW 2112.

Best wishes to all 

Graham Middleton