23 November 2019
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Metcash surprises short sellers

Andrew Main
27 June 2017

By Andrew Main

Grocery and hardware group Metcash has proved emphatically to short sellers that standing between a Scottish CEO and a cost saving program is a strategy that can easily land them in grief.

Indeed Metcash, whose boss Ian Morrice intimated on Monday that he would be standing down next year after five years at the helm, achieved a one-two punch on short sellers on Monday by turning in a better than expected full year profit, and resuming dividends ahead of time, after an 18-month gap.

Metcash has been one of the most shorted stocks in the Australian market, thanks to the clearly simplistic belief that it will never survive the cornucopia of supposed negatives from the various bogeys of Woolies, Coles, Aldi and Amazon.

Aldi is building up capacity in two of Metcash’s stronghold states, South Australia and Western Australia, while Amazon keeps popping up in conversations as the potential ruination of much of Australia’s retail industry.

Morrice told the media that he doesn’t see Amazon as a huge threat given that it hasn’t focused elsewhere on fresh food.

“We think they will start with their marketplace format and that will have a much bigger impact on the discretionary sector than it will do in food,’’ he told The Australian.

“And where they have operated in the food area, both in the US and UK, it tends to be in the premium sector and consequently prices are actually higher, and not particularly competitive in food industry markets.”

Not surprisingly the share price kicked up by 5% on the dividend and result news, rising 11 cents to a two month high of $2.30, before easing back yesterday morning to the pre-result level of $2.19. Metcash closed yesterday 3.9% lower to $2.21.

The company will pay a final dividend of 4.5 cents, fully franked, in late July. It hasn’t paid a dividend since late 2015, the year when Metcash turned in a net loss of more than $380 million.

Management had long signalled that there would be no new dividends until 2018, which is what must have taken the shorts by surprise.

Given what a tough life it is in the grocery sector at the moment with price deflation rampant, just achieving a flat result in that area was well received by the market, which expected a 5% drop.

The final result for the year to April 30 saw underlying net profit of $194.8 million against expectations of around $188.7 million, thanks in particular to cost savings of around $40 million.

Metcash, which not so long ago had the painful experience of having a hailstorm cave in the roof of one of its warehouses, was able to point to a 5.4% increase in revenue for the year to $14.12 billion, helped by an extra trading week in the year plus higher earnings from liquor and hardware.

Hardware is a small but sharply growing part of the Metcash business, given it added what had been Woolies’ Home Timber and Hardware (HTH) operation to its existing Mitre 10 arm in late 2016. Hardware sales were up a stellar 52% at $1.6 billion and earnings not far behind, up 48% to $48.5 million.

Announcing that sort of number must feel a lot like treading on Woolies’ foot, considering how much money Woolies lost with its (admittedly much bigger) failed Masters hardware foray.

It’s worth noting, by the way, just how fragile the growth in grocery and overall sales is. The 53rd week allowed the company to announce small growth in overall (up 1.3%) and food (up 0.6%) sales, but without that extra week those numbers would have been respectively 0.6 and 1.3% down from the previous year.

Metcash’s reported net profit fell 20.6% to $171.9 million, thanks mostly to the restructuring and integration costs that followed the Home Timber and Hardware purchase, an entirely expected item.

But for all the upbeat noises from Messrs Morrice and Co, the broking analysts aren’t jumping out of their skins about Metcash’s prospects.

FNArena’s consensus target for the stock is $2.39, which is only a modest premium to the current price.

Let’s start with the fans, headed by Macquarie and Morgan Stanley.

Macquarie has retained an “outperform” rating and a target of $2.60, noting that the company “is continuing to deliver.” It damns Morrice with faint praise, noting that his tenure “has focused on balance sheet repair,’’ and that a new CEO could be more growth oriented.

They don’t say it but Morrice has cut net debt from $686 million to $81 million.

Morgan Stanley is also keeping an overweight stance, with a target of $2.80, cheering the cost cutting and maintenance of grocery earnings.

“When the supermarket sales performance improves, the broker expects the company to re-rate. The potential in the hardware business is also under-appreciated, in Morgan Stanley’s view.’

Citi is neutral, with a target of $2.50, but reckons the reported 9% growth in net profits in the interim update overstates the real momentum inside the business. The analysts say growth was more like 3.2% during the six-month period.

UBS was the gloomiest of the analysts, maintaining a Sell on the stock.

It reckons the cost reductions produced a positive surprise in cash flow but that cost cutting can only work for so long. East coast competition is re-emerging and investment in price will be required, the broker says.

But there’s clearly value in watching a pessimist such as UBS find a silver lining. It’s lifted earnings forecasts and with that, has lifted its target on the stock from $1.85 to $2.00.  

My conclusion? It’s somewhere between a Hold and an Overweight. Metcash is a small dog running close to the tall grass with the big dogs.

It’s clearly very tightly run and the company’s done all it can to position itself well, but there are bigger influences out there that could still make life hard in the medium to longer term.

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