About: Wesfarmers is an Australian conglomerate with interests predominantly in Australian and New Zealand retail, including Coles, Bunnings, Officeworks, Kmart and Target. Wesfarmers also owns industrials businesses (in Chemicals, Energy & Fertilisers and Resources) and has subsidiaries in many Asian countries and the UK.

Why it’s in the portfolio: Together with Woolworths Ltd (WOW), WES represents a quasi-duopoly on the Australian retail sector. As such, WES provides investors with a diversified and wide-raging exposure to the Food & Staples Retailing sector of the Australian economy. Part of WES’s appeal is that it’s a conglomerate with individual businesses at different stages of their corporate lives: some like Coles, Kmart and Bunnings (which recently benefited from the closure of its main competitor Masters) are quality businesses that have grown steadily in the past and may grow at a slower pace in the future. Others, like Target and Bunnings UK, are either struggling or young and offer the potential for turnaround and faster growth. The resources business, while dependent on commodity prices and therefore volatile, has actually contributed to WES being a low-volatility stock by adding to its diversification. In the first half of 2017 strong results from the resources division has compensated for weakness in the supermarket one. So far in 2017 WOW has also managed to reduce its debt.

Fundamentals: WES currently trades on a price-to-earnings ratio of around 16x forward earnings, and a price-to-book ratio of 2x. WES currently offers around a 7.5%-8% gross dividend yield, and a dividend payout ratio of around 87%. At 14%, WES’s level of debt relative to assets is considered to be low.

What could go wrong? While Consumer Staples companies are typically less sensitive to weakening economic conditions, WES operates in a competitive environment. Over the last few years, it appears WES has opened a lead over its main competitor WOW, but all that good news is reflected in the current price. WES’ future growth and profitability could be threatened by an apparent return to prominence of WOW, or by the growing imprint of foreign retailers in the Australian landscape (e.g. Aldi, Lidl, and Amazon). The reduced debt level could be an indication that WES is preparing itself for a large acquisition, which carries risks as well as opportunities. Furthermore, over the last few years WES’ dividend yield has been consistently higher than its Current Earnings Yield and Free Cash Flow Yield, which raises questions over the dividend yield’s sustainability.