By Chris Shaw
Before Metcash (MTS) reported its interim profit result yesterday, JP Morgan had been the only broker in the FNArena database to take a negative view on the stock, its Underweight recommendation contrasting with three Buy ratings and six Holds.
Post what was viewed as something of a disappointing result, the ratings tally looks different, the database showing Metcash is now rated as Buy just once, with seven Holds and two Sells as Macquarie, Bank of America Merrill Lynch and Credit Suisse all downgraded their ratings, the latter two to Hold from Buy and the former to Sell from Hold.
For Bank of America Merrill Lynch the result was disappointing as while Metcash earned net profit of $109.2 million for the six months, the company only recorded 6.6% sales growth for the period. There was also evidence of increased competition from the likes of Coles ((WES)) and others, a trend expected to continue going forward.
This supports the Macquarie decision to downgrade to an Underperform rating as well, as Maqcquarie analysts take the view competition will erode any superior returns Metcash may have expected to achieve. This is especially the case as sales growth at its operations is proving to be disappointing, with Coles now appearing to be growing faster in at least some categories.
Credit Suisse takes a similar view in that it sees the trend of increasing competition emerging in the interim result as a good indication Metcash will experience a slowing in profit growth from existing operations in coming years. The margin issue is magnified according to JP Morgan by the fact ongoing cost reductions are needed in the IGA Distribution business to offset lower price and cost inflation.
In JP Morgan's view, the intrim result also suggests IGA Fresh will have a prolonged negative impact on margins, while operating leverage in that business is now likely to return only to levels of 1.3-1.4 times rather than management's previous target of 1.5 times.
This means the growth option offered by the proposed acquisition of Mitre 10 becomes more important in creating some upside potential for the company, but again views are mixed on the benefits of the move. From JP Morgan's point of view, the issues include the likelihood cost savings will need to be reinvested in the business, while JPM also sees some potential problems in changing the culture of the organisation from a co-op into a more efficient company.
For Macquarie the big issue will be generating enough earnings from (proposed acquisition) Mitre 10, as on its numbers EBIT (earnings before interest and tax) is likely to be around the $4 million mark, which is well below the $35 million target of management.
For management's number to be achievable Macquarie suggests a large number of current Danks stores will need to migrate to Mitre 10/Metcash, while it would also require a large number of independents to survive in what will be a tougher market with the entrance of Woolworths ((WOW)).
As Bank of America Merrill Lynch puts it, while the proposed entry into hardware is interesting the fact competition in that sector will be increasing in coming years means it will be tough going for management to generate the returns they hope to from the investment.
Post the interim result, Bank of America Merrill Lynch cut its earnings forecasts by around 4% through to FY12, so in earnings per share (EPS) terms it now expects 31.5c in FY10 and 34.2c in FY11, while minor reductions by Credit Suisse mean its estimates stand at 31.4c and 33.9c respectively.
Macquarie cut its EPS numbers by around 2% to 30.9c in FY10 and 31.6c in FY11. All this compares with consensus EPS forecasts according to the FNArena database at 31.6c and 33.9c respectively. The average price target according to the database is little changed post the result, falling just 1c to $4.71.
Shares in Metcash today are slightly weaker and as at 11.10am the stock was down 1c at $4.58, which compares to a range over the past year of $3.80 to $4.74.
