23 November 2019
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Is Metcash ready for a new sensation?

Andrew Main
21 June 2016

By Andrew Main

It’s not often a company’s announcement revealing plans to resume paying dividends coincides with its share price falling more than 12% in a day, but Metcash has made it clear there are choppy seas ahead.

The company announced on Monday that in the year to April it had a statutory profit of $216.5 million compared with a $384 million loss the previous year, but the latter included a massive write-down and on a like-for-like basis, the underlying profit was up by a much more modest 2.7% to $178.3 million.

The shares closed 26 cents lower at $1.86 on June 20 when the overall equity market was up strongly.

Metcash is an unusual beast in that it’s basically a grocery wholesaler, while competitors’ Coles, Woolies and now Aldi control the retail process as well.

Metcash supplies mainly to IGA stores, many of which are independently owned.

Scottish CEO Ian Morrice, who is tolerant of jokes about how tight he is with shareholders’ money, conceded that if you want to see the glass as half-empty, there’s plenty to back your view.

“Highly competitive trading conditions remain in all our markets,’’ he noted, adding that there would be “additional impact from increased food and grocery competition in both the South Australian and West Australian markets.’’

That reference to SA and WA was a reminder that those two states, which had been something of a fortress for his business, are now under direct siege from Aldi, which is building out chains of supermarkets around Adelaide and Perth.

That’s most of the Metcash-sourced bad news out of the way.

There are some significant patches of blue sky out there too, which might help explain why two major investment banks have markedly differing views on the outlook.

Macquarie’s still got it as an Outperform with a target of $2.51, marked down three cents from the previous $2.54 target.

“Results did not achieve quite the seasonal mix Macquarie had forecast but supermarket earnings did improve, which suggests a stabilisation of the business in a difficult environment,” said a research note.

Based on Macquarie’s numbers, the stock is set to return 35% this year to shareholders buying now, and that’s before the expected final dividend of 6.4 cents a share, on a Price-Earnings Ratio (PE) of 9.56 times.

Meanwhile UBS can’t see a dividend of more than 5 cents a share and has it firmly as a sell, with a target of $1.30.

It’s worth noting, by the way, that sentiment on the stock has picked up sharply this year, lifting the share price from a level just below $1 late in 2015. It’s likely that some of that has come from a feeling that the write-off last year cleared the slate, plus there are some positive indicators in hardware and liquor that I’ll go into in a moment.

Back on the gloom scenario, UBS says that ‘‘the results, while in line, suggest to UBS that the headwinds continue.

“While the company’s strategy is sound, the broker believes execution risk is high, particularly given the competitive pressures from the likes of Aldi.

And there’s more.

“UBS expects long-term share and margins will fall in grocery. A Sell rating is maintained as the broker considers the business structurally challenged.’’ Oof.

If you look at Metcash solely on its grocery business, you can’t argue with that.

It’s had to drop prices (and profit margins of course) via its Price Match program designed to match prices at Coles and Woolies. Indeed, deflation is noted by Metcash as one of three negatives affecting the grocery division, along with competition and a rising cost base. They haven’t had a plague of frogs yet, but they did have part of the roof of their Sydney distribution centre cave in last year by a massive hailstorm.

That cut total supermarket sales growth for the year, the company said, from a planned 0.9% to 0.5%.

On the bright side … they’ve cut debt sharply, cutting net debt from $668 million to $276 million, a drop of $392 million.

A good part of that is the net $242 million it banked in mid 2015 from the sale to Burson Group of the automotive business for which it had paid just over $53 million in 2012.

That was originally for 75% control, subsequently lifted, but you can see Metcash did a good job with the business.

That’s particularly important when you remember that the company is in the running to bid for Woolies Home Timber & Hardware stores. Woolies is a seller and Metcash has already asked for a ruling from the ACCC on any potential deal, given that it also owns Mitre 10 and True Value hardware.

Getting control of Home would be quite a new sensation for Metcash, finding itself potentially in a strong position in the hardware market up against only one major player, Wesfarmers’ Bunnings.

They’re currently fending off three in grocery, so hardware’s almost a holiday.

Metcash’s dealings with the ACCC have more traditionally been exasperated squeaks from them about being beaten up by Coles and Woolies, and that was before the German family-owned, unlisted Aldi got serious.

Last but not least, Metcash has seen good results from its Liquor business, which comprises, among others, Cellarbrations and the Bottle-o stores.

In the latest year, liquor stores lifted sales by 3.7% and earnings by 7.8%.

Metcash did even better in hardware, growing sales by 0.8% and earnings by 9% thanks to lifting efficiencies and keeping a tight control on costs.

Conclusion? They’re good managers of businesses but they are right up against it in the big league business of groceries.

There’s the knotty question of whether the company’s going to continue suffering from other bigger players’ regularly noted market power.

Hardware and liquor are growing well, but liquor’s only a third of grocery’s already reduced sales volume, and hardware’s half the sales of the liquor division.

It’s going to be a long haul in the core business, and that’s if everyone else behaves.

Metcash (ASX:MTS) closed at $1.93 on June 21.

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