By Christine Chen and Himanshi Akhand

SYDNEY (Reuters) -Australia's biggest non-food retailer Wesfarmers said consumer demand was beginning to recover due to easing inflation and interest rates after reporting a higher annual profit and proposing a A$1.7 billion ($1.10 billion) capital return.

The conglomerate, which owns Australia's most popular hardware chain Bunnings, and discount retailer Kmart, posted on Thursday a net profit of A$2.65 billion for the 12 months ended June 30, up 3.8% from a year earlier.

Wesfarmers CEO Rob Scott said the result, in line with estimates, was driven by strong performances at its retail businesses as shoppers began to loosen their wallets.

"We have seen a modest improvement in consumer demand and confidence in recent months, and the easing of interest rates is expected to provide some further relief," he said.

The Reserve Bank of Australia has cut rates three times this year, bringing the official interest rate to 3.6% at its last meeting in August as inflation returned to its target range of 2% to 3%.

While geopolitical uncertainty and U.S. tariffs posed risks to growth, Scott said he was confident the company would be able to adapt given the sophistication of its supply chain capabilities and its teams.

"These are just risk factors that all businesses have to manage," he said.

Earnings before tax for Kmart jumped 9.2% to A$1.1 billion, which Scott attributed to "good growth" in transactions and customer numbers.

Scott said consumers were "resonating really well" with its in-house brand, Anko, and there was more appetite for premium product offerings at higher price points.

"Consumers are feeling a bit more confidence to invest a bit more ... but also it recognises the quality of the Anko product and the fact that the Anko product is now starting to resonate with higher income families and customers," Scott told reporters.

"It's pleasing to see customers prepared to spend a bit more."

Bunnings, the group's biggest division, reported a 3.8% rise in earnings before tax to A$2.34 billion. Sales growth was driven by strong demand for home repair and necessity products, Wesfarmers said.

"Bunnings and Kmart remain the growth engines ... as households traded down to value but kept spending on home improvement and essentials," said Farhan Badami, a market analyst at eToro.

Shares in Wesfarmers were flat in morning trade, but are up more than 28% this year.

The company proposed a capital return of A$1.50 per share, or A$1.7 billion, subject to shareholder approval at its annual meeting in October. It is expected to comprise a capital component of A$1.10 per share and a fully-franked special dividend of A$0.40 per share.

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It also lifted its final dividend to A$1.11 per share fully-franked, up from A$1.07 a year earlier.

Separately, Wesfarmers announced the appointment of former BHP Group Chairman Ken MacKenzie to succeed Michael Chaney as its chairman, effective in June 2026.

($1 = 1.5389 Australian dollars)

(Reporting by Christine Chen in Sydney and Himanshi Akhand, Sameer Manekar and John Biju in Bengaluru; Editing by Edwina Gibbs and Jamie Freed)

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