Broker Views Diverge On Metcash

This story features METCASH LIMITED, and other companies. For more info SHARE ANALYSIS: MTS

Grocery, hardware and liquor wholesaler/retailer Metcash provided plenty for brokers to chew over in its first half results on a wide-ranging outlook for the stock.

-Cost reductions tracking to plan and continuing diversification away from food & grocery
-Roll out of Aldi expected to have significant impact on SA, WA in next three years
-HTH expected to provide material upside from the second half
 

By Eva Brocklehurst

Grocery, hardware and liquor wholesaler Metcash ((MTS)) provided something for everyone in its first half result. That is the opinion of UBS. It also reflects a wide range in broker expectations for the stock. Cost reductions were ahead of expectations and hardware synergies were upgraded following the acquisition of Home Timber And Hardware (HTH). Management has outlined a synergy target of $15-20m by the end of FY18.

Declines in top line grocery sales accelerated, down 4% ex tobacco in the half, but the company has guided to a lift in second half grocery earnings. Convenience stores are expected to be profitable in the second half compared to the $4.3m loss incurred in the first half. UBS believes the company is doing a good job, with cost reductions tracking ahead of plan and price perceptions improving.

While the business continues to diversify away from food, UBS believes this division will need to retreat further over time. The broker retains a Sell rating, noting cost reductions cannot last forever and the company is structurally challenged in the long term even though the turnaround strategy is delivering results for food & grocery the near term.

UBS expects that the roll out of Aldi into South Australia and Western Australia will have a significant impact on supermarket earnings in the next three years and Metcash has the most to lose, given its high 25-30% share of that market.

Macquarie highlights greater clarity for the second half earnings outlook and the synergy benefits from the HTH acquisition. While the first half was mixed in terms of food & grocery, much of this is blamed on the continuation of a poor performance in convenience that is now largely rectified. The broker believes the company's diversification strategy is beginning to deliver, with the earnings profile now being driven from the liquor and hardware divisions.

While competition may be tough, the company's agenda for cost reductions and its strategic plans continue to underpin growth of compound 8% over the next three years, in the broker's calculations. Macquarie believes that Metcash is the only one of the three supermarket stocks to be pricing in a discount war into it share price and maintains a Outperform rating.The broker expects HTH will provide material upside with its second half earniungs contribution expected to be over $10m.

The broker notes the company is shifting its focus on private labels towards a higher quality mid-range product and there is increased weighting of tobacco in the sales mix. While the increase in tobacco excise appears to have had a positive impact on Metcash at the sales line, plans for further excise increases are aimed at reducing consumption and this will be a risk for the company as it increases its dependency on tobacco sales, Macquarie suggests.

The company also flagged a material increase in multi-store owner activity in terms of acquisition, refurbishment and new store expansion in NSW. This is an important development, in Macquarie's view, given the company's under-utilised distribution centre assets in that state, and it addresses an under-penetrated market in NSW, particularly for differentiated premium retail formats.

Credit Suisse also notes that unless capital expenditure or restructuring costs are significantly higher, the company is likely to financially de-leverage quickly over the next several years. The main supports for the company's outlook, in the broker's view, are continuing store upgrades by independent retailers and delivery of cost reductions which improve the competitive position of the wholesale business. Credit Suisse finds some validation for both of these points in the first half result.

If food distribution earnings stabilise and growth is achieved from hardware and liquor distribution, the broker considers the stock would appear cheap at 10 times FY17 earnings per share estimates and retains an Outperform rating.

Deutsche Bank is at the other end of the spectrum with a Sell rating, believing the recently enlarged hardware business will struggle to grow sales as competitor Bunnings ((WES)) continues to gain share. The broker believes wholesale sales growth, ex tobacco, is the main indicator of the health of the company's core food & grocery division and this metric deteriorated sharply over the last six months.

The weakness is attributed to the usual structural pressures as Aldi rolls out in SA and WA and Woolworths ((WOW)) begins to recover. Deutsche Bank downgrades forecasts for food & grocery as well as liquor across the forecast horizon to reflect lower earnings margins in food & grocery and lower-than-expected growth in liquor.

Following the acquisition of HTH the company is re-naming the Mitre 10 stores, to encompass its wider business, to Independent Hardware Group (IHG). This group will operate in an attractive market in which a large competitor (Masters) is closing, Morgan Stanley's notes.

The market is fragmented and the broker believes there is a long-term opportunity to gain market share as well as turn around company-owned stores. The growth of IHG diversifies away from the supermarket industry and as the market begins to better understand the opportunities for IHG the broker believes that Metcash shares will re-rate.

Morgan Stanley believes earnings have bottomed in food & grocery, and hardware should deliver significant growth ahead. The broker notes customers are paying back loans more quickly and working capital is being managed more tightly, hailing these aspects as hallmarks of a business that is being run better.

Ord Minnett downgrades to Hold from Accumulate as the results, while ahead of expectations, were disappointing in terms of composition. Food & grocery revenue and earnings margins both declined and the outlook is considered challenging despite the assistance of the company's Working Smarter strategy.

While improved synergies with HTH are pleasing to the broker, these are considered incorporated into the aggregate hardware earnings outlook. Ord Minnett believes the competitive environment will consume much of the Working Smarter cost savings. While the company is executing well, the position of its customers, in aggregate, is not strong, and this will weigh on the competitive position of the wholesaler, the broker asserts.

FNArena's database has three Buy ratings, two Hold, and two Sell. The consensus target is $2.23, suggesting 6.6% upside to the last share price. Targets range from $1.60 (Deutsche Bank) to $2.80 (Morgan Stanley). The dividend yield on FY18 forecasts is 6.6%.
 

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