Momentum Improving For Metcash

This story features METCASH LIMITED. For more info SHARE ANALYSIS: MTS

Metcash has gained market share in grocery since the start of stockpiling in March and while an easing of restrictions may diminish gains going forward, some of the changed habits may stick.

-New customers generated from the pandemic restrictions
-Slowdown in comparable food sales growth likely in second half
-Hardware acquisitions consolidating Metcash's position in trade
 

By Eva Brocklehurst

Momentum is improving for Metcash ((MTS)) although the company's FY20 result reflected elevated operating costs towards the end, amid the recent stockpiling during the onset of the pandemic restrictions.

Credit Suisse suspects the result has probably missed more optimistic expectations but there was enough in the food division to support a solid outlook for FY21. The broker underestimated the additional costs required to meet the spike in demand, and profit leverage was therefore significantly lower than usual.

CLSA notes, while operating cash flow appeared very weak it was temporarily affected by significant investment in inventory in order to service the sales growth currently being achieved.

To date first half sales have accelerated, with grocery up 17%, liquor up 5.5% and hardware up 9.4%. The pandemic has provided new customers which, coupled with price investment, should improve medium term sales. More broadly, Ord Minnett points out Metcash is benefiting from a food retail industry where inflation is occurring and competition, while aggressive, is not irrational.

Metcash has gained market share in grocery since the start of stockpiling in March as shoppers favoured smaller stores, closer to home, that were outside of high-traffic shopping centres.

Credit Suisse believes the structural headwinds for IGA retailers will continue but also notes the potential for some permanence in localised shopping, which is of a strategic benefit to the independent grocery sector. Localisation, along with online expansion (of benefit to the large supermarket chains), are the two features of the current restrictions which are, presumably, going to continue to some extent.

However, Citi is more sceptical, believing the competitiveness and habitual nature of grocery shopping will mean shoppers return to their typical patterns over time and sales for Metcash will return to market levels.

UBS suspects Metcash is still facing a structural loss of share over the medium to longer term, although with a robust market backdrop and the independent grocers winning share this is more than priced in.

Morgan Stanley believes the stock warrants a higher multiple compared with history, given its diversification and balance sheet strength. The broker lifts FY21 estimates by 6% to reflect a modest increase in anticipated food earnings.

FY21

Under normal circumstances, Credit Suisse would assume a 6% earnings margin on incremental sales and estimates Metcash achieved 2.0% in the second half of FY20. While incremental margins were disappointing, management has indicated an improvement should occur as the profile is more predictable going forward compared with March and April.

Citi estimates sales growth was 25% in April before moderating to 17% over the past seven weeks. Some of the tailwinds are likely to dissipate over the rest of the first half of FY21 and the broker forecasts 5% underlying growth, in line with the market.

While expecting underlying food sales and earnings growth of 8% in the first half, Citi asserts this is more than offset by contract losses and will drive a headline -7% fall in first half food earnings. A further slowdown in growth in the second half, amid the challenge of cycling strong sales, should result in just 2% underlying growth on the broker's calculations.

Hardware

Hardware is showing some resilience in the face of slower trade demand, yet Credit Suisse expects trade will turn negative in the second half of FY21 as government housing stimulus moderates. Goldman Sachs observes Metcash has taken advantage of the volatile conditions to consolidate a position in trade-focused hardware, through bolt-on acquisitions.

The company completed two acquisitions, one in Victoria and one in South Australia, during FY20. This signals a strong move towards achieving significant scale in the segment, the broker adds.

The latest acquisition of 70% of Total Tools for $57m is an example, with the transaction yet to be completed. Total Tools is a franchise business in the trade market with more than $550m in sales and 81 stores.

Following both the equity raising and build in working capital, Metcash has options to increase its dividend and invest around $100m in bolt-on acquisitions, over and above the $140m already announced, Citi assesses.

Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, has a Buy rating and $3.27 target while CLSA, also not one of the seven, reiterates a Buy rating with a $3.40 target. There are three Buy ratings on the database and three Hold. The consensus target is $3.12, suggesting 8.2% upside to the last share price.

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