Australia | Mar 17 2021
This story features METCASH LIMITED, and other companies. For more info SHARE ANALYSIS: MTS
Metcash has outlined a wide ranging strategy to accelerate growth in hardware and retain recently-acquired market share in food, although the amount of expenditure is a little eye watering
-Mitre 10 to account for 80% of division sales by FY24
-Regional growth providing impetus to food division sales
-Retention of market share gains key to a re-rating
By Eva Brocklehurst
Metcash ((MTS)) has shaken the market out of its lethargy, revealing substantial growth plans for its hardware division while accelerating its supermarket refurbishments and expanding eCommerce.
Management has guided to $375m in growth capital expenditure for FY22-24, with around 60% being allocated to hardware. In tandem, the company's dividend pay-out ratio has been increased to 70% of underlying profit.
Goldman Sachs suspects first impressions were negative, because of the extent of the planned capital expenditure. Nevertheless, management appears increasingly confident in the underlying stability of the business, while the strong housing sector is being captured with increased allocations to hardware.
There was a lot to like in the briefing, although Credit Suisse acknowledges some may have issues with the amount of capital expenditure being undertaken for growth. Yet, justification can be found in the opportunities that present in hardware and, specifically, Total Tools.
The broker also notes that money is being spent on upgrading and acquiring stores, for which there is relatively more objective proof of returns. Expenditure on the digital offering could also potentially be considered a "stay in business" requirement.
Expenditure is double the level Citi had anticipated, which rules out a capital return over the short term. Still, the broker is optimistic about a return on hardware because of the company's strong position in trade.
Metcash provided no specific guidance on the amount of debt funding required, although Credit Suisse notes the increased dividend pay-out should ease investor concerns regarding potential returns from the investment.
As a result, the overwhelming majority of the investment is expected to be met from operating cash flow. Execution will be critical, although Morgan Stanley highlights the new strategies are occurring at a time when the business is on a solid financial footing.
In hardware, the company will increasingly concentrate on the Mitre 10 brand, expecting this to account for 80% of division sales by FY24. An additional nine stores per annum is targeted for Total Tools, partly franchised and partly corporate owned, adding to the current 88 store count.
Morgan Stanley is particularly positive about the hardware segment, given strong housing market conditions and the company's skew to the regions. Metcash plans to deploy $95m across FY22-24 in Total Tools, predominantly by growing the store network, with a target of 130 stores by FY25.
DIY now accounts for an increasing share of hardware sales and Metcash has noted that kitchens, bathrooms and garden were categories that drove foot traffic to its stores during the 2020 lockdowns. The company continues to focus on promoting products that are not available at Bunnings ((WES)).
In the supermarket division, distribution is achieving a 6.5% growth rate and while the recent strength cannot necessarily be construed as sustainable over the long term, Credit Suisse highlights regional migration as a structural support.
Metcash intends to upgrade around 90% of the food network by 2026. Food sales growth was 4.1% in the first four months of the second half, compared with 9.5% in the first half, the drop largely a result of the loss of the 7-Eleven contract.
The broker suspects investment in format and price positioned the business well for a lift in traffic from the pandemic, and much of this business has been retained. Ord Minnett also highlights a strong capital position has provided Metcash with the confidence to lift its dividend.
Liquor sales were up 20% over the four months, driven by extended consumption at home, with Macquarie asserting Australia's pandemic-driven alcohol consumption appears to be a habit hard to shake.
At-home consumption is also supported by regional growth and less travel overseas. That said, the broker believes, despite the performance of independent supermarkets exceeding expectations over 2020, market share gains are likely to "normalise" as the economy re-opens.
Morgan Stanley believes the stock's current discount to the market is too steep and retains an Overweight rating on the stock. Jarden, not one of the seven stockbrokers monitored daily on the FNArena database, also has an Overweight rating with a $3.70 target, finding the valuation attractive and believing the food business has potential in the top line that is not priced in.
The market, in the broker's view, is pricing the Metcash food division as a structurally declining business and there is scope for a re-rating if the market share gains hold. Moreover, these appear to have been more sticky than many expected as years of work on price, range and store refurbishment pay off.
Despite the dividend pay-out increase, Goldman Sachs, also not one of the seven, believes a low net debt position can be maintained over FY21-23 and there remains room for capital management, retaining a Buy rating and $4.03 target.
The database has four Buy ratings and two Hold. The consensus target is $3.91, signalling 13.2% upside to the last share price. The dividend yield on FY21 and FY22 forecasts is 4.7% and 4.4%, respectively.
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