Wesfarmers Limited (WES) Earnings Call Transcript & Summary

Thank you for holding, and welcome to the Wesfarmers 2021 Half Year Results Briefing. [Operator Instructions] This call is also being webcast live to the Wesfarmers' website and can be accessed from the homepage of wesfarmers.com.au. Without further ado, I'd now like to hand the call over to the Managing Director of Wesfarmers Limited, Mr. Rob Scott.

Thanks very much. Well, good afternoon, and good morning, everyone, on the call, and welcome to our 2021 half year results briefing. I'm joined here in Perth with a number of our leadership team, and then we have some others in Melbourne on the phone amongst our managing -- divisional managing directors. I'll provide an overview of the group's performance, following which Anthony will provide some more detail on the financials. The divisional managing directors will then talk to their performance and the outlook of their respective businesses. And I'll conclude with the outlook for the group, and then we'll move to Q&A. So just starting on Slide 4. The results for the first half were strong. But as you know, we don't judge our success over such a short-term horizon. What pleases us about the results is that we're seeing the benefits from the 3 areas of strategic focus that I've been talking about in recent years, and we've continued to invest in these areas. These 3 areas relate to: number one, positioning our businesses in the portfolio for future growth, accelerating our data and digital capabilities and then addressing areas of underperformance. This is all about providing a satisfactory return to our shareholders, which we define as a top quartile TSR over the long term. We believe it's only possible to achieve this over the long term if you provide support to your broader stakeholders, as set out on this slide, which is a slide you should be very familiar with by now. Moving to Slide 5. During the half, we continued to demonstrate this in a number of ways. For almost a year now, we've supported our team, our customers and the community with paid pandemic leave, commitments to pay team members during lockdown periods and additional community support. Our investment in data and digital over recent years positioned the group to respond well to rapid changes in customer preferences and to support more vulnerable customers through COVID. During calendar 2020, Wesfarmers businesses created almost 10,000 additional jobs. Over 800 new Aboriginal or Torres Strait Islander team members also joined our group, and we're well on the way to employment parity. Across the group, we continue to manage our businesses with carbon awareness, and that focus saw our emissions reduced by 8% in the first half, which is pleasing progress towards our net zero targets and aspirations. It's also worth noting yesterday's approval of the final investment decision for the Mt Holland lithium project. Ian Hansen will be able to talk more to this soon. Now turning to Slide 6 and our results for the half year. The group experienced strong retail sales growth of 19.2% in-store and online, and this is more than 1.5x overall market growth in Australian retail sales, excluding food. Total online sales, excluding Catch, were more than double last year and including Catch online sales of $2 billion were recorded for the half. Reported net profit after tax was $1.39 billion, and net profit after tax from continuing operations was $1.41 billion, an increase of 25.5%. On dividends, our directors have determined to pay a fully franked ordinary interim dividend of $0.88 per share, an increase of 17%. Turning to Slide 7. Bunnings, Kmart and Officeworks delivered strong trading results for the half, reflecting their ability to adapt to changing customer preferences and provide a safe and trusted environment for customers and team members. Good progress was made to accelerate the growth of Kmart and improve the performance of Target. The simplification of Target's business and store conversion program is progressing well. On a combined basis, Kmart and Target delivered a record earnings result for the period. Chemicals, Energy and Fertilizers delivered a good operating performance, particularly having regard to the increase in supply from a competitor ammonium nitrate plant during the period. Industrial and Safety's results also benefited from an improved performance in Blackwoods. Then finally, on Slide 8. The group has maintained its strong focus on generating an acceptable return on capital with most of our divisions delivering an improved ROC. I'd like to thank our divisional managing directors, Mike Schneider, Ian Bailey, Sarah Hunter, Ian Hansen and Tim Bult for their leadership that has delivered the results that we're discussing today. I'll now hand over to Anthony, who'll walk through the group's balance sheet and cash flows for the half.

Thanks, Rob, and good afternoon, everyone. I'll start on Slide 11, which provides a summary of other business performance. In total, our other businesses and corporate overheads reported a loss of $1 million for the half, which compared to a profit of $72 million in the prior corresponding period. The key driver to the lower result is the reclassification of the group's remaining 4.9% shareholding in Coles as a financial asset. This reclassification means our result no longer includes a proportional share of Coles' net profit after tax. Instead, we only report dividends received during the period, which during the half was $18 million. It's also worth noting that any movement in the value of our residual holding in Coles will be taken to equity and not reported through the profit and loss. The net reduction in the reported contribution from Coles of $55 million together with a lower contribution from the group's investment ingression more than offset the benefit of higher property revaluations in BWP Trust as well as the $6 million reduction in our corporate overheads. Turning to working capital and cash flow on Slide 12. Divisional operating cash flows increased 16.1% for the period, which was supported by strong divisional earnings growth. As highlighted at our full year results, lower working capital inflows during the half -- this half reflect the ongoing normalization of working capital positions across our retail businesses following the favorable but temporary movements, which we recorded towards the end of the 2020 financial year. The working capital result also reflects the targeted investment in Kmart to increase stock weights in some categories, providing greater flexibility to accommodate demand fluctuations from COVID-19. We're pleased with the progress that was made in Kmart during the half to improve inventory availability, which supported stronger sales growth through the Christmas trading period. Our payables also remained elevated at the half, which reflected the continued build in inventory across the retail businesses to support the strong sales growth. We expect to see further normalization of our working capital position into the second half of the year. As a result of the lower working capital inflows, divisional cash generation was 111% for the half, which was slightly below our 5-year average. At a group level, operating cash flows increased 4% and were impacted by the timing of tax installments, which was significantly higher during the half. As a result, the group's cash realization ratio finished at 102% for the half. Turning now to capital expenditure on Slide 13. Gross capital expenditure was $410 million for the half. This reflected continued investment in data and digital capabilities across all of our divisions as well as the conversion of 19 Target stores to Kmart stores, but was offset by lower capital expenditure on new stores and refurbishments in Bunnings and across Kmart Group. Net capital expenditure for the half increased 17.4% to $243 million due to reduced property activity, resulting in lower proceeds from Bunnings property disposals. For the 2021 financial year, we expect net capital expenditure for the group to be between $650 million and $800 million. This estimate reflects ongoing store network activity, our continued investment in data and digital projects and capital expenditure associated with the Mt Holland lithium project following yesterday's announcement of our approval of FID on the project. Turning to balance sheet and debt management on Slide 14. The group's continued to retain a strong balance sheet with flexibility to support further investment in the group's businesses. At the end of the half, the group recorded a net cash position of $871 million, reflecting the strong operating cash flow performance and the actions taken last year. During the half, the group recorded a $9 million reduction in other finance costs due to lower average debt balances following the repayment of $500 million in domestic bonds in November. Our weighted average cost of debt increased slightly to 4.38% due to a shift in the mix of debt towards our remaining European bonds. We continue to maintain our focus on managing our lease portfolio to balance network flexibility and security of tenure. Our average remaining lease tenure reduced to 4.7 years during the half, supported by the store closures and conversions within Target. Our work to reposition the Target network has supported a 14% reduction in its lease liabilities since the 2020 financial year. Further detail on our lease portfolio is included on Slide 20 -- sorry, Slide 47 of the presentation. Overall, we are pleased with the strength of our balance sheet, which provides flexibility to respond to the significant uncertainty associated with COVID-19 as well as to support the continued investment in the long-term growth of our businesses. To the extent that we have capital that is surplus to these requirements, we will look for opportunities over time to return it to shareholders in the most tax effective manner. Turning now to dividends on Slide 15. As Rob mentioned, the Board determined to pay a fully franked interim dividend of $0.88 per share, reflecting the strong net profit after tax result for the half. This dividend is consistent with our dividend policy, which seeks to maximize the value of franking credits to shareholders, while having regard to current year earnings, credit metrics and forecast cash flow requirements. The group will again provide shareholders with the option to participate in the dividend investment plan, and we expect that shares for the plan will again be purchased on market. And with that, I'll now hand over to Mike Schneider.

Thanks, Anthony, and hi, everyone. I'd like to start by acknowledging the incredible hard work from the Bunnings team and our suppliers in the face of considerable challenges last year. The team has worked tirelessly to keep everyone safe, responding to ever-changing regulations in different states and regions and to keep our customers served and our stores stocked. Now starting on Slide 17 and looking first at our safety results. Importantly, our #1 team measure, TRIFR, or total reportable injury frequency rate, continues to improve, down from 10.4% in the prior corresponding period. This is a pleasing result as we continue to progress towards our goal of ensuring that every one of our team members goes home safely every day. Operating revenue increased 24% to $9 billion for the half, with earnings before tax increasing nearly 36% to $1.27 billion. Excluding property, the property contribution, EBT increased 39%. Now turning to Slide 18. Total store sales growth of 25% was achieved during the half, with store-on-store sales growth increasing by 28%. Driven in part by the extended lockdown in Metropolitan Melbourne stores over a number of months, online penetration rose to 3.1%. All major trading regions performed strongly, and the trading performance across all product categories showed strong growth, led by gardening and outdoor living products across barbecues, furniture and lighting. Approximately $16 million was invested in the half in additional cleaning, security and personal protective equipment to operate safely in response to COVID-19. In addition, we also continued to pay our team in full during all COVID-related trading restrictions during the half. Return on capital increased to 76.6% as a result of strong earnings growth and continued disciplined capital management. Turning to Slide 19. Despite the highly complex trading environment, we haven't skipped a beat in progressing our strategic agenda. We've continued to invest in our team, the customer experience, along with service and digital innovation to drive growth throughout this period. To improve the customer experience, we continued to proactively lower prices across a wide range of categories and products. We also recruited over 6,000 additional team members across Australia and New Zealand to service higher demand, and I welcome these team members to the Bunnings' family. With the health of our supplier partners, we further improved the ease of shopping for customers to reflect their shopping habits through product display upgrades and refreshed ranges, including garage organization and kitchen design. Further enhancements were made to the website experience through improved functionality and expansion of our online range. Customers continued to respond well to the convenience of the Product Finder app, which helps them research and find the products they need in-store, meaning they get in and out of our stores more quickly. Customers also continued to enjoy the convenience of online ordering through our click and collect, contactless drive and collect and click and deliver services, continued strong support from suppliers associated with good inventory management, particularly in light of high levels of demand. We also continue to strengthen our relationships with commercial customers through expanded product offerings, particularly in our supply and install offers for builders, which expanded to support MBIs and retirement living refurbishment as well as current offers across kitchens, plastic boards, insulation and staircases. We also introduced a number of initiatives to further improve service for our commercial customers. A successful trial of a new trade service desk format was completed, providing a dedicated service area that improves the customer transaction experience. And the next phase of this will be rolled out in the second half. Over 1 million transactions were completed through the PowerPass app over the last 12 months and functionality continues to improve. The performance of Adelaide Tools was pleasing, and we're excited to be opening our newest format store in Parafield, South Australia. Our locally based Adelaide Tools team is doing a great job, and we anticipate more stores opening late in 2021. Now turning to Slide 20. Whilst the outlook remains uncertain, the home improvement and lifestyle sector is expected to continue to benefit from consumers spending more time in their homes. Sales and earnings growth is likely to moderate from March, particularly as we cycle the uplift from COVID-19 in the prior year and as government stimulus programs come to an end. Costs associated with operating safely and complying with government regulation in a COVID-19 environment will continue to be incurred for the foreseeable future. However, we are well positioned for continued growth and are committed to investing for the long-term success of our business through continued digital innovation and capabilities, broadening commercial market and strengthening our in-store offer. We expect to open 6 stores in the second half, all of which are currently under construction. To finish, I'd again like to thank our teams and suppliers, who have done an outstanding job dealing with the ever-changing trading conditions over the half, minimizing disruption to trading and looking after our customers, while keeping each other and the community safe. That's it from me, and I'll now hand over to Ian Bailey.

Thanks, Mike, and hi, everyone. Kmart Group's focus during the pandemic is on being there for our customers, keeping our team members, customers and communities safe and making the right decisions to set our business up for future success. I'm exceptionally proud of our team and the way they have performed through the uncertain times and very difficult operating conditions. And I'm very grateful and thankful to work with such a wonderful team. Overall, Kmart Group has been a net beneficiary of strong retail demand in the first half, with some categories benefiting from the shifting consumer preferences, while other categories have seen significant declines. Consumer shopping behavior has changed with customers reducing the number of visits in-store, but spending more with us for a visit. The online channel has grown rapidly across all our brands, and we have also absorbed many incremental costs during this time. Importantly, each business has made significant progress on their longer-term strategic agendas. Now turning to Slide 22. Safety is a key priority for Kmart Group, and we have made good progress, with the total recordable injury frequency rate decreasing 34% to 10.6% during the half. Kmart Group delivered revenue of $5.4 billion, up 9% for the half. Including gross transaction value for Catch, Kmart Group revenue increased 12.4% or over $600 million for the half, demonstrating the group's ability to grow incremental market share. Earnings before significant items grew by 38.4% on the prior year to $487 million. Now turn to Slide 23. Kmart's comparable sales increased 9.1% in the half, with home, toys and active categories growing strongly. This translated into the strongest earnings half Kmart has delivered. Kmart started the financial year with an improving trend in product availability. But as the half progressed, unprecedented disruptions in international shipping, combined with local port congestion, resulted in considerable delays for us and many other businesses. Kmart's scale and strong relationships have enabled us to minimize the impact to customers, demonstrated by improvement in our Net Promoter scores through the half. These disruptions are expected to persist into the second half, and we will continue to make incremental investments to support key product lines and leverage strategic relationships with our shipping partners. Target's comparable sales increased 13% in the half, driven by a combination of strong retail demand and the considerable work undertaken over the last 2 years on improving the core product ranges. Target's profitability also improved significantly in the half. As more customers chose to shop online than ever before, Kmart and Target reported record online penetration of 8.7% and 15.9%, respectively. While this channel is profitable, we have significant opportunity to optimize our online operations, and we continue to invest in replatforming Kmart's website to improve the customer experience. Turning now to Slide 24. The strategic changes announced last year to grow Kmart and create a smaller and simpler Target are delivering strong results. The conversion of select Target stores to Kmart is progressing well, and the much larger Kmart store network is expected to unlock additional scale benefits to underpin Kmart's future growth. 19 targeted stores were converted to Kmart during the half, including 7 smaller-format K Hub stores, with initial results well above expectations. We have also created over 860 net new roles in Kmart conversion stores, predominantly in regional communities. Solid progress was made in Target to simplify the business operations and overhead structure and prioritize online growth. In Kmart, we have continued to invest in key strategic initiatives to enhance the customer offer. This includes in-store RFID technology to enable a more efficient and agile operating model and greater stock visibility and continued development of data and digital assets and capabilities. Turning now to Slide 25. Catch's gross transaction value increased 95.6% in the prior period with strong performance in both the in-stock and marketplace segments as more customers shopped online and the product offering was expanded into new categories and brands. As per previous guidance, Catch's earnings performance reflects accelerated investment in warehouse automation, technology, marketing and team capabilities necessary for the business to scale ahead of future top line growth. Catch now ranges increasing numbers of Kmart and Target products and is expanding click and collect options across Kmart and Target stores. Now turn to Slide 26. As we have previously said, FY '21 is a year of investment for Kmart Group as the foundations are laid for a significantly larger and more digitally enabled Kmart, a smaller but more profitable Target and a rapidly growing Catch. These investments are focused on improving the customer experience, both in-store and online and on making the business a great place to shop that is simple to run and delivering better products at even lower prices. By using technology to leverage Kmart's strengths, its brand, ability to leverage prices profitably and leading product development capabilities, we see enormous potential to continue to grow this business. We expect to incur one-off costs or one-off nonoperating costs of approximately $90 million to $110 million for the full year relating to Target store closures and conversions to Kmart. For Catch, we see great opportunity for continued growth in the online market, and we will continue to accelerate our investment in that business to fuel that. Thank you, and I'll now hand over to Sarah Hunter.

Thanks, Ian, and hi, everyone. I'm pleased to be joining you today to report that Officeworks has continued to deliver strong sales and earnings growth during the half. Turning to the next slide. Safety, health and well-being of our team members and customers remains a priority for Officeworks. We continue to adopt best practice safety and hygiene measures across our operations to ensure our team feels safe coming to work and our customers feel safe when shopping with us. From a financial perspective, revenue grew by 23.7% to $1.5 billion. Earnings grew 22% to $100 million, and return on capital increased to 23.4%. Turning to the next slide. Officeworks' ongoing focus on and continued investment in our every-channel proposition allowed the business to respond quickly to changes in customer behavior during the half. Online sales penetration increased to 37.1%, driven by periods of particularly strong online sales growth when access to stores was restricted. Sales growth was supported by strong demand for technology and furniture products, and customers also responded positively to our Christmas offer with our STEM early learning, and art and craft ranges proving particularly popular for gifting. Strong earnings growth of 22% was delivered despite gross margin compression as a result of changes in sales mix and continued investment in price. COVID-19 restrictions adversely impacted sales in higher-margin categories, such as print & copy and office supplies. The significant growth in online sales did require some additional resourcing to support peak demand, resulting in higher fulfillment costs. Turning to the next slide. Despite the changing circumstances surrounding COVID, we continued to invest for the long term to deliver our strategy. The safety, health and well-being of our team members remains paramount, and there is always more to do in this space to ensure that our team goes home safely every day. The mental health of our team was a particular priority, and we supported them by investing in a number of initiatives and, very importantly, offering pay and work certainty during the COVID lockdowns. We launched our Diversity and Belonging program, and we've made significant progress in indigenous team member employment. We also expanded our analytics capability with the launch of Phase 1 of the Officeworks data and analytics platform, and our range has continued to evolve to meet changes in customer demand. For example, expanding our cleaning and hygiene range to enable small businesses to continue to operate safely and launching our new exclusive art brand, Born. Over a period when our communities really needed support, we contributed over $3 million to local groups and our national partners, and good progress was also made to reduce emissions. Investment in our supply chain capacity across every-channel enabled greater flexibility to manage COVID restrictions and customer demand. And we continued to invest in growing our business. We upgraded store layouts, opened 2 new stores, made enhancements to our mobile app, online checkout and delivery options for customers. Our new Geeks2U subscription service continues to grow and complement our technology offer. And we also made significant investment in replatforming and building a new integrated website for our print & copy and create business, which will deliver a materially improved experience for customers. Turning to the next slide. While the outlook is uncertain, Officeworks remains well positioned for the future. We are expecting sales and earnings growth to moderate from March as we begin to cycle the initial sales impact of COVID-19. We will drive long-term growth by investing in our team, the customer experience across every channel, enhancing capacity of our supply chain and improving productivity through use of technology. We will continue to invest in opportunities to grow our core business as well as expanding into adjacent areas in B2B and in education. I would like to take this opportunity to recognize and thank the amazing Officeworks team for delivering yet another half of positive progress under extremely challenging circumstances. Thank you, and I'll pass over to Ian Hansen.

Thanks, Sarah, and hello, everyone. Overall, WesCEF has continued operations and supported customers across the chemical, energy and fertilizer industries we serve without significant impacts from COVID-19. I'd like to acknowledge the great contribution of all our team members in achieving this. And I'm very pleased that during this ongoing phase of disruption, we've maintained our good safety performance. Turning to Slide 33. You can see that each of our business segments experienced a decline in revenue with earnings impacted as a result. Overall, this decline was less than expected, given this is the first reporting half when the competing Burrup plant has been in operation, coupled with lower and volatile energy prices throughout the half relative to the prior corresponding period and reduced fertilizer volumes due to the late season in 2019 that was not experienced in 2020. We have been pleased with the resilience of the business and a strong return on capital. Turning to Slide 34. As you are aware, Wesfarmers, together with joint venture partner, SQM, announced a final investment decision for the Mt Holland lithium project. The project establishes a new growth opportunity and market sector for WesCEF. It aligns with our strategy of investing in adjacent markets and identifying new opportunities, where we can utilize our core capabilities in project development, sustainable chemical processing and product distribution. WesCEF has successfully built chemical processing plants and moved into new markets over its history with process plants to produce various acids, chlor-alkali, sodium cyanide, ammonia, ammonium nitrate and AN emulsion plants, just to name a few. This project is a key focus area for myself and the senior leadership team at WesCEF, and we continue to provide all necessary support to the Covalent joint venture to ensure sound project execution. The announcement follows the completion of the updated definitive feasibility study, which is the culmination of 12 months work and has provided the joint venture partners with greater certainty on the project's engineering design and cost. Importantly, we've also optimized the project to increase the annual production capacity to 50,000 tonnes per annum with Wesfarmers share being 25,000 tonnes of battery-quality lithium hydroxide per year at full production. Turning to Slide 35. I will now address the performance of each of the business units. The chemicals portfolio generally faced positive customer demand fundamentals with buoyant commodity prices and the industry avoiding significant COVID production interruptions. The strong ammonium nitrate demand from the iron ore sector was offset by increased supply from the competing Burrup plant, which impacted the sales result. Ammonia earnings were marginally down on the prior period due to the planned 2-week shutdown of our plant. The cyanide business has seen export volumes and spot pricing negatively impacted by COVID-related mine disruptions in several export markets. Furthermore, some increased cost pressures were experienced within chemicals due to short-term supply chain issues related to COVID. Now to the Energy segment. The Kleenheat LPG business experienced a volatile period, reflecting global energy markets. Earnings from LPG were down slightly on the corresponding period with higher export sales, offset by a lower average Saudi CP, the international indicator price. The natural gas retailing business continued to grow its residential customer base in Western Australia. The LNG business increased earnings slightly due to improved margins and volumes. Now to Fertilizers. While not as material as the second half due to seasonality, fertilizer earnings declined on the prior corresponding period due to a drier end of season in calendar year 2020 compared to the late rains and, therefore, higher fertilizer sales in the same prior year period. The business is benefiting from a newly commissioned liquid storage facility in Kwinana and has continued to invest in data and digital capabilities to enhance its service activities and customer experience. Now turning to Slide 36. In terms of outlook for the businesses, within the chemicals portfolio, the demand for ammonium nitrate is expected to remain stable. The ongoing disruptions to some offshore mining jurisdictions is likely to continue and could impact cyanide export demand in the short term. In the longer term, we still expect growing demand from the gold sector, and the team are investigating opportunities to expand production capacity. The Kleenheat LPG business will likely benefit in the 2022 financial year from the imminent closure of the BP Refinery in Kwinana, resulting in reduced LPG production capacity in Western Australia. This will see an increase in Kleenheat's domestic sales volumes of LPG and a corresponding reduction in exports. The remaining energy businesses are expected to be stable. With respect to fertilizers, the recent 2020 Western Australian harvest was above average, which will assist grower sentiment. However, second half earnings will remain dependent upon the timing and extent of the seasonal break in autumn and may be impacted by increased competitive pressures in the West Australian fertilizer market. Thank you, and I'll hand over to Tim Bult.

Thanks, Ian. Before I begin, I'd like to commend the hard work done by all the teams in the Industrial and Safety businesses over the past 6 months of activity, particularly following on from the challenging times we faced in the second half of the last financial year and as our teams navigated this into the first half of this year, where the challenging operating environment continued. Our businesses did a great job of continuing to support our customers in response to COVID-19 during the period through sourcing of critical products, ensuring critical oxygen supply to hospital groups and providing additional risk consulting services. Turning to the half year results on Slide 38. Industrial and Safety's earnings grew from $22 million to $37 million before the payroll remediation costs that were incurred in the prior year. The earnings performance was primarily driven by Blackwoods, which was in line with our expectations. Safety remains a key priority for us. The total reportable injury frequency rate increased slightly to 4.5 in this half. However, that was a stable result given the current operating environment. In relation to the specific performance of businesses within Industrial and Safety on Slide 39, I'll start with Blackwoods. Revenues grew in Blackwoods due to continued growth from strategic customers and strong demand for critical products in the first quarter, including respiratory, cleaning and hygiene products. This was partially offset by weakness in some coal mining, oil and gas and manufacturing sectors. Investment to date to improve Blackwoods' operational execution supported the reliable supply of products despite COVID-19-related shipping disruptions, and this was a strong achievement by the team. Earnings increased from the higher sales and cost improvement initiatives, partially offset by continued investment in customer service and digital capabilities, including the enterprise resource planning, or ERP, system. Turning to Workwear Group. Earnings were in line with the prior year with lower revenue from uniforms as a result of the impact of COVID-19 on some customer segments, including airlines, retail and hospitality. Pleasingly, these were offset by higher revenues from the industrial workwear brands, including KingGee and Hard Yakka, together with operating efficiencies within the business. Coregas' earnings increased on the prior year due to the higher demand from industrial and health care customers, reflecting investment in the product offerings in these segments in recent years. The business also benefited from improved material sourcing costs, which was a good outcome. Turning to the outlook for Industrial and Safety on Slide 40. Market conditions are expected to remain uncertain and challenging for the remainder of this financial year. Blackwoods continues to focus on improving its customer value proposition. The business will build on improvements to its core operational capabilities, including through progressing the implementation of the ERP system. Customer demand in Workwear Group will continue to be impacted by COVID-19. The business continues to focus on growth from key brands, cost improvement initiatives and continued investment in its digital offering. Customer demand in Coregas is expected to remain stable with continued strength in health care and industrial segments, offset somewhat by weakness in other sectors and ongoing competitive pressures. Thank you. I'll now pass back to Rob.

Thanks, Tim. Now turning to Slide 41 and the outlook for the group. Economic conditions in Australia have recovered strongly, and the outlook is now more positive. Sales across the group's retail businesses have continued to remain strong through January and February, with some impact from government-mandated trading restrictions. It is apparent that we need to learn to operate in a COVID-safe way for some time to come because there continues to be risks and uncertainties, particularly as we seek to contain the virus and with the risk of future lockdowns. Effective and well-coordinated COVID management in areas such as hotel quarantine, test, track and trace capabilities and adopting more measured and sophisticated approaches to outbreaks will help to reduce the enormous harm on families and businesses from hard lockdowns and will ultimately support the economic recovery. Australia is in a unique position to manage the challenges of COVID-19, and it's important we focus on longer-term strategies that will sustain our future prosperity. Consumers spending more time at home and working from home, while the restrictions -- while other restrictions persist, is likely to support higher demand for some of our group's businesses. The group will continue to invest in our digital offer to meet the changing needs of customers, while also improving operating efficiencies and always managing our businesses for the long term. Regarding the Mt Holland project, we're excited about the opportunities with this project. This is a very long-term project and one where Wesfarmers and our partner, SQM, brings some very specialist and highly complementary expertise and experience. The group's portfolio of cash-generative businesses, the leading market position remains well positioned to deliver satisfactory returns over the long term. Now that brings us to the end of the briefing. We'd now be very happy to take your questions.

[Operator Instructions] Your first question today comes from Michael Simotas from Jefferies.

My first question is on capital allocation. And in particular, how you're thinking about the balance sheet at the moment? And maybe a comment on the interim dividend that's been declared because the payout ratio looks like it is a little bit at the lighter end, notwithstanding the very strong earnings and cash generation. And how you're balancing the opportunity to invest in existing businesses, invest in new businesses and return capital to shareholders?

Thanks, Michael. I'll take that question. So firstly, as I think we mentioned, it's a really good time to be sitting on a strong balance sheet at the moment, given the uncertainty around COVID, and we see that playing out, obviously, with the recent lockdown. So I think it's a good environment to have a strong balance sheet in. We continue to invest in our existing businesses. As you know, our philosophy is very much about getting franking credits back to shareholders. So we're not sitting on surplus franking credits, and that's because we've managed to pay those back to shareholders as we've earned them over the years. So we will continue to look at capital management opportunities as we go forward. But I think at the moment, we are comfortably sitting on a strong balance sheet, which allows us to invest in our existing businesses. Sorry, in terms of the interim dividend, you're right that the $0.88 probably represents a slightly lower payout ratio. As you know, our interim payout ratio is always lower than our full year payout ratio. We haven't moved away from our full year payout ratio range. The current interim represents about a 72% payout ratio. Typically, we're between that and about 75%. We have seen a shift a bit in earnings pattern across the halves. So that's impacted that decision slightly, but it doesn't change our approach to dividends over the longer term.

Okay. Yes, that's helpful color. And then just a second question for me on the retail businesses. A lot of retailers have demonstrated significant margin expansion as you have. And some of that's been operating leverage and some of it's been gross margin expansion as a result of the very strong demand. You've given us some very useful commentary on margins for Officeworks. So I was just hoping you could give a little bit of qualitative color on gross margin performance across the other retail businesses, please?

Yes, Michael, it's Rob here. Look, I'll answer it at a high level and each of our retail MDs can provide a bit more color. Look, I think there are a few things. It's important to understand the differences in each of our businesses. So if you take a business like Officeworks, as Sarah was saying, there was a very significant change in sales mix, such that some of the higher -- the impact of COVID on Officeworks was that some of the higher-margin products, such as print & copy, we saw a decline in demand. And some of the lower-margin products, particularly on the technology side, we saw a very strong demand. If you contrast that to, say, Kmart and Target, them selling more product at full price and less discount and clearance is clearly going to give a gross margin benefit. On the Bunnings side, Bunnings being an everyday low price retailer and being deeply committed to keeping low prices, as all of our businesses are, I should say, you wouldn't expect such an increase in gross margin. And indeed, it's not how we focus on the businesses. The other point I'd say is that the objective of all of our businesses and the group is not simply to ask the question of how much operating leverage and how much profit can we make in a 6-month period. As I said and as our MDs have said, we've continued to invest heavily. We've invested heavily in our team, heavily in COVID-safe practices, continue to invest heavily in setting our businesses up for the future. So we're quite pleased with the extent of leverage that we achieved, but we're also pleased with the foundation that we've set for the future.

Michael, it's Mike Schneider here. I'll just add to that. Pretty much as Rob said. But for us, as I said in my sort of opening remarks, for us, we've been continuing to invest in pricing as an EDLP retailer. It is something we are fixated on in terms of delivering for customers. So yes, for us, it's been more about leverage than margin.

Yes, Ian Bailey here. Michael, just a few points from Kmart Group side of things. I think it's -- obviously, margins have been positive for the reasons which were called out where we've had less clearance in the mix. There's also a cost story in there, too -- on the way through. So obviously, we've been converting Target to Kmart. Those conversions delivered greater sales density and greater sales in those stores. So of course, that translates through to the bottom line, particularly as you get the fractionalization of the fixed cost of the Kmart business. And of course, within Target, last year, we actually had quite high clearance levels. So we had an unusually low margin number and obviously, benefited this year with the stronger margin at full price. But equally, we've done a substantial reduction in costs in that business as well, which has been a contributor to the result. So it's a combination of margin and costs in Kmart and Target.

Your next question comes from Shaun Cousins from JPMorgan.

Just a question, hopefully, Mike, that you can answer, just regarding Bunnings. Can you talk a little bit about what was stronger in terms of the contributor to revenue growth, whether it was DIY or trade? And whether or not you've seen the DIY market become a bit larger than what you had anticipated previously? And then how are you thinking about trade into calendar '21, calendar '22 cycling, the strong trading that you've got, but also how you're positioned for a renovation or a housing investment cycle there? Hopefully, some answers in there, please.

Shaun, yes. Look, I think we sort of talked for quite a while about the fact that we sort of -- because we can see the trade customers through PowerPass, that sort of 35, 65 split of revenue sort of is continuing, and both have seen a good lift in sort of volumes across the period. There's no doubt in my mind that Australians and New Zealanders have fallen back in line with doing things around the home. Some of that will have been out of necessity and some of it is very much about staying occupied, particularly if you think about Melbourne, where we've had 3 months of being locked down. It was very much a case of seeing people stay really active at home. I think that on the trade side, there's certainly a lot of activity both on new starts and on [indiscernible] when you think about what's going on with how the churn is, there's a lot of interest in that. So we're really well positioned. We've been working really hard over the last 12 months to improve the capability of the trade team. So we've got a new trade Chief Operating Officer, Ben McIntosh, he joined us last year and a number of new leaders across the 3 categories of Bunnings Trade, which is really helping us focus on sales and relationship management, alongside the technological development improvements in PowerPass. It's great to see so many trades and small businesses using the app. It increases convenience and speed and time in store, but also a lot of really good work on product innovation and the in-store experience with the new trade service desk that I touched on earlier. And it creates a much better experience for trading when they're in-store and on the way through. And obviously, during periods of lockdown, we're fortunate that the business can be open for the trade to do emergency repairs and things like that. So obviously, that's been a benefit during the first half. But yes, we've got a really positive outlook for what we can do in Trade in terms of improving the way we go to market and the quality of the service offered, and I think that will benefit us in increased sales.

And so to be clear, so you didn't see any divergence in the growth rates between trade and DIY? They both grew at the same amount and stayed at 35% -- trade stayed at 35%. Is that what you're saying there?

Yes, pretty much.

Okay. Perfect. That's helpful. And my second question is maybe just for Ian. Can you maybe sort of provide us a little bit of detail around what are you seeing from the Target conversions in terms of broadly what have been the ranges of sales uplifts in that generally Kmart stores generate much greater sales than a Target store and they're obviously also more profitable? What are sort of -- can you share any financial metrics around how these sort of -- how these conversions are progressing, please?

Yes, sure. I think first thing, Shaun, it's very early days. So I'll put that caveat on there. But so far, the performance of the stores have been stronger than expected. Now when we look at the economics of the store, it's very much a rational financial assessment. So we'll assess the costs of establishing the new Kmart, so that includes the cost of closing the Target, that includes the cost of the fit-out and so on and that said again, obviously the incremental revenues that we get post that. And that then gives us a sales profile for those stores. We're consistently overachieving against that sales profile that we have within those business cases, but I say very early days. In the case of the K Hubs, which is a small format, we're seeing very strong growth in those relative to their historical levels as Target Countrys. And the reaction we're getting from customers in the communities where we've opened has been incredibly strong. So I can't give you any numbers. I think even I did, I'm not sure how useful they will be because of the stage of the life cycle we are with those. But I would say the early indications give us a lot of confidence for what's coming in the second half.

Your next question comes from Grant Saligari from Crédit Suisse.

Ian, could I just continue, perhaps just on Target, specifically, so the reposition Target formats. Obviously, incredibly hard to judge, I guess, underlying performance given the period we've been through. But are there any other proof points that you could point to in terms of where you've got the cost positioned to where sales might have been some of the more stable ranges that could support progress and the turnaround of that Target business?

Yes. So it's a good question, Grant. I think a couple of things. The -- we've analyzed the performance in many ways and trying to isolate out the net benefit of COVID is not a simple equation. Obviously, some categories have seen really strong performance and the other categories have seen the opposite. And if you look at both Kmart and Target, we would sort of class ourselves in the middle of the retail market, being benefiting in some and not in others, clearly with a net benefit position, I should hasten to add. When we look within the categories, I'd say the work we've been doing around quality and style at an affordable price, I think we're starting to get traction. I say, I think, because it's so hard to isolate that out from the environment that we're in. But when we look at rates and say out of the products that we would say are delivering on our brand proposition, we're seeing those rates of sale being higher than some of the other products. We've also been infilling the range where we felt like we were missing products within categories that were more on the basic end, and they have performed well. So we feel like that is a real number that's going to continue to stay with us. So when you look at the underlying health of the merchandise software, I would say good progress, but none of us are declaring that we're at the destination at this point, and we have more to do. As we go through the second half, though, what we do have is we have a continuation of the closures and conversions to Kmart, and we have a continuation of the reduction in the cost base of Target. Now both of those things are working well. The closures are generally performing well up to the point of closure, which is one of the reasons why the one-off costs are reducing from what we initially predicted. And then the cost base is very much on track for where we wanted it to be. So I think by the time we end this half, we're going to have a very different target, which is smaller than it was historically. It is very focused around quality, style and affordable price. And I feel like we've made a good start on that journey of getting to a sustainable level of performance. But I don't think any of us are declaring victory just yet.

Sure. I appreciate that. If I could ask one other question, perhaps to team just in Industrial and Safety, which has been the other repositioning and restructuring task. Are there any -- again, are there any proof points that you can talk to with that business? I mean it's obviously pleasing to see the profit going up in the half, which is the first time for a while we've seen that. But in terms of the cost base of that business, you mentioned the ERP system is sort of approaching, I guess, the final implementation phase. I'd be just interested in where that business is at in terms of progress with its turnaround?

Thanks, Grant. I'm guessing you're referring primarily to Blackwoods in that case, but correct me if that's not the case. Look, I think there has been some good progress with the team led by Rachael McVitty around cost management and the business has certainly become more efficient. We've seen some good growth in sales, as I outlined, notwithstanding the difficult operating environment we're in. Now it's a really mixed bag because some customers have performed very strongly, and the business has had some good success with its major strategic customers in terms of growth. But then we've had really reduced demand, not losing customers, I might say, but reduced demand from some customers that are in heavily affected segments where the COVID affected their operation or it's reduced their price of their products and, therefore, their level of activity. We've also had some benefit from -- which may not be lasting around hygiene-related products that have, I guess, resulted from the impact of COVID-19. In aggregate, COVID-19 has not been good for the business, but there has been some offset, as I say, in relation to those products. It's very early days. If we look at the division at the moment, its return on capital has improved from 3.4% last year to 5.4%, but that's in no way satisfactory. We've got a long way to go. We're building some early momentum, but it's very early days. In relation to the ERP, both the team within Blackwoods and with the support of our new implementation partner have done an enormous amount of work. They're very well advanced. The build process of the new system is complete, and we're deep into data migration and user acceptance testing. It's a very complex project with us approaching 0.25 million SKUs. We're well advanced, but still with quite a bit of work to do, and it's an important investment clearly for the business and very much part of the focus for us going forward.

Your next question comes from Andrew McLennan from Goldman Sachs.

Anthony, I completely agree it's a good time to have a strong balance sheet with the uncertainty around COVID, et cetera. But I think even after paying for the Kidman development, you're going to have $4 billion to $5 billion of capital in excess of the A minus credit rating. And I think I saw your paying phase on undrawn -- $2 billion of undrawn banking facilities, it doesn't appear that you're sitting on that kind of balance sheet position from a conservatism perspective. It's -- I imagine you'd be paying that down, et cetera, if you didn't have plans for that capital. What is the -- what are you guys waiting for? I mean obviously, it's an expensive market at the moment, but you previously said you'd return excess capital to shareholders if there was no other purpose for it. I'm just wondering how we can overcome this balance sheet issue at the moment.

Yes. Thanks, Andrew. Look, there's no doubt, we've clearly got a strong balance sheet. We're not hiding behind that fact, and we're sitting on net cash. I think the reality is, though, as we've always said, and I think we've got a history of doing this, is getting share -- getting capital back to shareholders when we don't have a need for it. The reality also is that we are still in a COVID environment, and it's still a level of uncertainty, and we continue to see that on a daily basis. And I also -- as I mentioned before, around our franking credit position, we want to be able to do this if we're looking at giving capital back to shareholders. We want to be able to do it in a tax effective way. We're not sitting on a meaningful balance of franking credits that would allow us to pay out a very large special dividend. So we need to look at other forms of capital management if that's appropriate at a point in time. And there are other means of doing that. They will require shareholder approval. So we'll need to consider how that plays out in the future. But I think there's no doubt, it's a great time to be having a strong balance sheet and take the point that from an efficiency point of view, we're paying a small cost for that at the moment. But in the context of where we sit and the growth opportunities that we're looking at, we think that's in the best interest of shareholders.

Okay. And one for you, Rob. I think in terms of the outlook statements from Wesfarmers, I've always thought that your comments have been very balanced. This time around it's clear that the view is much -- is certainly more optimistic. And I'd note that for most of your retail businesses, you're talking around the outlook as so the growth would moderate and certainly given the very high base, that's not surprising. But it doesn't sound as though you're at all anticipating profitability to go backwards. Can you just confirm if that's an overinterpretation of how you've been explaining the outlook for the retail businesses, please?

Well, Andrew, I'm certainly not giving any forecast on profitability. You'll recall back in August, I was quite -- I was very cautious, and that was at a stage where we were facing month -- very extended lockdowns, an enormous amount of uncertainty with COVID, not -- we were still working through government stimulus response and so forth. Where we sit now, clearly, the data shows that the economy has bounced back very strongly. So I guess my statements are just a statement of fact that we've seen unemployment reduced, jobs have come back, savings rates are a lot higher, consumer spending is -- and confidence has improved. My comments are also with the caveat that risks and uncertainties remain. And as Anthony said as well, the virus is changing month-on-month with various mutations. We have snap lockdowns week-on-week that are not anticipated, and we read about them and hear about them in the media. We can't just ignore those things. They do represent risks. So I think we've got a lot to be pleased about and optimistic about in Australia in particular, but we shouldn't lose sight of those risks. I think what we've also demonstrated through our performance in 2020 is that our portfolio of businesses and our teams have been able to adapt and respond really effectively. So we've gained a lot more confidence in our capacity to manage this volatility and uncertainty and still deliver good outcomes. So yes, we do feel more optimistic, but we shouldn't ignore the fact that there are still risks that remain.

Your next question comes from David Errington from the Bank of America.

Rob, can I ask you this question, it's very broad, but -- and maybe Ian Hansen can follow in as well. Why is investing in lithium, and I understand EVs, but can you give us a bit of an update, why you think that is a really good investment for Wesfarmers, given you've spent, what, $780 million acquiring Kidman, then you're putting in another $950 million for your 50% stake? Can you give us a bit of an overview as to -- no, I understand EV demand is strong. But can you give us a bit of an overview, why you think this is a great investment for Wesfarmers in the long term, please, given that it's likely to dilute returns for next 4 or 5 years? Because they are very long duration and they are pretty capital intensive. And there is a lot of supply coming on to the market.

Yes. So David, I'll touch on that and then Ian can talk more. There isn't a lot of supply coming on to the market, particularly on -- in lithium hydroxide. But I think if I take a step back, as you know, the way that our WesCEF division has grown over the years is by making significant investments of capital with a long-term view. And often, those investments are to support new industry opportunities that have arisen and where Western Australia possesses some unique points of competitive advantage. And you can look at that with the growth of WesCEF over the years, be it around the growth of its fertilizer, LPG business, the expansion -- the multiple expansions of ammonium nitrate, the move into sodium cyanide, the more recent move with emulsion. And lithium is a unique situation that we -- globally, there are some of the highest quality hardrock reserves here in Western Australia. The chemical process for converting concentrate to lithium hydroxide is -- has a number of very similar processes that lend itself to a lot of the expertise we have in Kwinana in chemical processing. So partnering with a world-class operator, a very experienced group like SQM, we think is a great opportunity to leverage some unique capabilities and assets that reside here in Western Australia, create a new growth platform for WesCEF, consistent with how we've grown WesCEF over the years. Now there's still a lot to do. Just to be really clear, this has nothing at all to do about Wesfarmers speculating on lithium mining or commodity prices. It's not about that at all. It's about building one of the best lithium hydroxide refineries with a global leader in that process, SQM, and we are very confident in the future demand for that product. And I might hand over to Ian. Ian can add to some of the detail on the project.

Yes. David, I think you have to look at it from the perspective that the Mt Holland deposit is very high grade relative to other deposits around the world. You add to that the fact that Western Australia is a mining jurisdiction. So we're used to mining here in Western Australia, and we have the infrastructure and the labor to support mining. And then on top of that, you've got the growth demand in the EV thematic. And if you look at the projected growth or demand requirements for lithium hydroxide in electric vehicles going forward, there's a big disconnect between forecast demand requirements and current supply capability. So we see the combination of that very high-grade lithium deposit, our ability to execute projects in Western Australia together with our chemical processing capability to refine the concentrate that will come from that mine into lithium hydroxide, working with our joint venture partner, SQM, who are experienced in the downstream processing of lithium and also the marketing of lithium. And it's just an opportunity that we see is there for Western Australia in lithium to become a major supplier into the growing battery electric vehicle market.

When you explain it like that, it sounds pretty compelling. So you're basically saying probably '25, '26, we'll start seeing some returns coming through. And then hopefully, a very long -- good long-term investment going forward. Is -- that's generally the theme, is it?

That's correct, David. I think we expect to be cash flow positive around FY '25 and thereafter, good returns.

And David, just a final point...

You got a good track record, Ian, so, yes, it's pretty well.

David, we acknowledge that this is a -- it's a big project. It's a long-term project, not without risks. But in the scheme of things, it represents around or just under 3% of our equity value. So it's a -- these are not the kind of things that we'd want to go out and make 5 to 10 different bets on. But in the context of the overall Wesfarmers' portfolio, given the capability and track record of our WesCEF team, we think it's an investment that should be good for shareholders longer term.

Absolutely. And this will be under Ian Hansen's influence and he'll be the one controlling it. Is that right?

Well, that's right.