The measure used by the Group to assess satisfactory returns is total shareholder return (TSR) over time. We measure our performance by comparing Wesfarmers’ TSR against that achieved by the S&P/ASX 50 Index.
Growth in TSR relies on improving returns from invested capital relative to the cost of that capital and growing the capital base at a satisfactory rate of return on capital (ROC)1.
Given a key factor in determining TSR performance is movement in Wesfarmers’ share price, which can be affected by factors outside the control of the company (including market sentiment, business cycles, interest rates and exchange rates), the Group focuses on return on equity (ROE) as a key internal performance indicator.
While ROE is recognised as a fundamental measure of financial performance at a Group level, ROC has been adopted as the principal measure of business unit performance. ROC focuses divisional businesses on increasing earnings and/or increasing capital productivity by managing factors they can control, as well as making an adequate return on any new capital deployed.
Minimum ROC targets for each division are set based on their pre-tax cost of capital, while satisfactory ROC targets are established based on the Group’s ROE targets, which are reviewed annually with reference to the performance of the broader market.
1ROC = EBIT/(Working capital, fixed assets and investments less provisions and other liabilities).
We believe that in order to deliver satisfactory shareholder returns it is important to try to achieve a cost of capital advantage, which is best done through a strong focus on cash realisation, the maintenance of a strong balance sheet and having flexibility in financing options.
Working capital and capital expenditure
The Group continuously looks to improve the working capital efficiency of all of our businesses, and also ensures strong discipline in relation to capital expenditure or any other investment decisions that are made.
Shareholder distributions and portfolio management
The Group endeavours to optimise shareholder returns through our dividend policy, our approach to capital management and disciplined portfolio management.
When reviewing the acquisition of businesses the Group applies various filters, as illustrated below. Importantly, in applying these filters the Group applies a long-term horizon to investment decisions and remains very disciplined in our approach to evaluation, with the most important filter being whether the investment is going to create value for shareholders over time.
continue to invest in Group businesses where capital investments exceed return requirements
acquire or divest businesses where doing so is estimated to increase long-term shareholder wealth; and
manage the Group's balance sheet to achieve an appropriate risk profile and an optimised cost of capital
Cash flow generation
In generating cash flow and earnings, the Group seeks to employ excellent management teams who are empowered to drive long-term earnings growth. This is achieved through deploying best practice principles in operational execution and maintaining a long-term focus to strategy and results. In addition, the Group manages working capital very closely and ensures that strong discipline in capital expenditure and investment processes are maintained.
Balance sheet strength
The Group endeavours to achieve a cost of capital advantage while maintaining balance sheet strength and flexibility in order to be able to act when opportunities arise.
Long-term shareholder returns
The Group aims to deliver satisfactory returns to shareholders through improving returns on capital invested. As well as share price appreciation, Wesfarmers seeks, where possible, to grow dividends over time. Dependent upon circumstances, capital management decisions may also be taken from time to time where this activity is in shareholders’ interests.