How much does Morgan Stanley think Wesfarmers shares will fall?

Wesfarmers Ltd (ASX: WES) shares have climbed substantially over the past three months, but broker Morgan Stanley warns the rally could be overdone.

Where to now for the Wesfarmers share price?

The shares have improved from levels in the low $70 range in April and May to be changing hands for $89.90 now, up a modest 8.16% over the past 12 months.

But Morgan Stanley warns that the re-rating in discretionary spend stocks has “run ahead of fundamentals and is unlikely to prove durable”.

Looking at the consumer sector broadly, the broker has downgraded its industry view to cautious from in-line, “following capital gains tax and negative gearing changes and the expected drag on housing activity, wealth effects, sentiment, and discretionary spending”.

They said that since the announcement of the tax changes, their cautious view had not changed, and they see the risk of derating as high.

Sector-wide, Morgan Stanley said companies were trading at high multiples, not far off 10-year highs.

They added:

Historically, valuation premiums at these levels vs. the market have required either accelerating earnings estimate revisions or a supportive macro backdrop. We see neither today, suggesting that the risk/reward balance has become increasingly unfavourable ahead of reporting season.

The broker has downgraded Wesfarmers to underweight, “following a period of strong share price performance that has pushed the stock’s valuation ahead of the likely earnings trajectory”.

They added:

While we expect Kmart to be a beneficiary of trade-down and range expansion (K home), we expect a moderation vs. consensus expectations in Bunnings’ sales growth, given the emerging correction in domestic property markets. Bunnings remains a high quality business with strong market positioning, attractive returns on capital, and structural opportunities across range, digital, loyalty, and store productivity. However, near-term expectations appear demanding. The emerging correction in domestic property markets is likely to weigh on housing turnover and renovation-related expenditure, particularly in larger-ticket and project-led categories. Maintenance and repair demand should remain comparatively resilient, but we expect softer discretionary spending to result in sales growth below current consensus assumptions.

Kmart, on the other hand, should be a beneficiary of pressure on household budgets, Morgan Stanley said, as consumers seek greater value for money.

They added:

Ongoing range expansion, including K home, provides an additional avenue for category growth and market share gains. Nevertheless, expectations for Kmart are already elevated following several years of strong execution.

What share price to expect

Morgan Stanley slightly increased its price target for Wesfarmers shares, upping it from $78.70 to $79.

The broker is expecting the dividend yield to be 2.7% this year.

The post How much does Morgan Stanley think Wesfarmers shares will fall? appeared first on The Motley Fool Australia.

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Motley Fool contributor Cameron England has positions in Wesfarmers. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended Wesfarmers. The Motley Fool Australia has recommended Wesfarmers. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.