Are Metcash Shares (ASX MTS) A Stock To Buy?

Metcash Limited Share Price (ASX MTS)

Henry Fung

Henry is a co-founder of MF & Co. Asset Management with over 19 years of experience as a trader, investor and asset manager. Henry is the instructor of the Professional Trading Course, which is a free 5-day course on how to become a profitable trader.

August 3, 2018

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Metcash (ASX MTS) is an Australian wholesale business that distributes and markets groceries, fresh produce, alcoholic beverages, hardware, and other consumer goods. The company has recently tapped into the Chinese market via collaboration with Chinese e-commerce firms. However, competitors such as global giant Aldi poses a huge threat to Metcash and they have suffered losses recently due to a loss of contracts with South Australian customers. With these issues, are Metcash shares a stock to buy now?

About Metcash (ASX MTS)

With $2.53 billion market capitalisation, Metcash (ASX MTS) is Australia’s leading wholesale distribution and marketing company with a diversified business across food, grocery, hardware and liquor sectors.

The company earns a negligible portion of its revenue through franchise fees, mainly generating revenue through exclusive wholesaling agreements.

Specialist In Independent Retail Supermarkets

Operating as a wholesaler for retailers, Metcash supports independents across Australia to compete with vertically integrated giants such as Coles and Woolworths, including those in remote areas where others don’t reach.

The company’s one-stop wholesale service combines pricing, refurbishment, marketing and other operations support.

Metcash’s Price Match program that’s been initiated in around 1,000 IGA stores, ensures pricing remains competitive with the major supermarket chains for both branded and private label products. Across 325 IGA stores, the Diamond Store Accelerator (DSA) refurbishment program has resulted in an average improvement in sales of over 10 per cent.

In rolling out all-rounded services, Metcash is proud to offer a real culture and spirit that supports independents throughout Australia, providing all the tools required to become the ‘Best Store in Town’.

Metcash Eyes China Growth With E-commerce Tie-up

As Chinese consumers are becoming more discerning over food quality, the B2B distribution business is gradually taking over the customer-to-customer daigou business, giving Metcash huge opportunities to utilise its retailing as well as wholesaling experience.

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In August 2017, China’s retail giant Suning Holdings Group signed a cooperation agreement with Metcash. The two giants now jointly promote and distribute Australian and New Zealand products procured by Metcash to all available channels both online and offline, which will significantly leverage Suning’s buying power in the region.

Metcash also collaborates with Chinese e-commerce giant JD.com and has recently launched a fresh pantry e-commerce concept store in the Chinese market. Chinese customers now have access to Australian and New Zealand products such as Vasse Virgin and Australian Diaries for the first time, providing significant opportunities for Metcash.

Fresh Pantry currently has two physical grocery stores in Australia, with another 10 scheduled to open later this year. Metcash also operates a store on Alibaba’s Tmall global platform.

Competition, Contract Loss and Heavy Investment Dampen Food Revenue

Although the acquisition of Home Timber and Hardware (HTH) increased MTS hardware sales by around 33%, grocery sales have dampened.

Metcash Shares (ASX MTS) total sales revenue

Intense competition in the grocery sector continues to put pressure on Metcash especially when competitor Aldi has continuously grown their market share in recent years.

In addition, another foreign supermarket establishing in Australia, Kaufland, also threatens Metcash’s market position. Metcash is in a weak position particularly in Western Australia where more competitors have started to enter the market.

Food deflation caused by a strong discount and promotion strategy of competitors like Aldi look to force Metcash to lower their prices and may decrease wholesale sales.

Metcash Shares (ASX MTS) supermarket and grocery

Metcash reported a bottom-line loss of $149.5 million in the past 12 months due to the impact of impairments of goodwill of $346 million on a post-tax basis, which stemmed from the loss of a big contract to supply Drakes, a major South Australian independent supermarket chain.

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The loss also rendered the new distribution centre useless, as Metcash had to make an increased effort to build up a new supply network. Citi analysts Bryan Raymond and Craig Woolford said last week that there is a risk Metcash could lose up to three more contracts up for renegotiation.

Even though Metcash’s Working Smarter program has helped the group save costs, it is doubtful whether the investment is worthwhile. Metcash is expected to invest an additional $10 million into fresh food, instant meals, and new smaller stores under IGA banner.

Furthermore, Metcash’s share buyback of $125 million also threatens to weaken its operating cash position.

Additionally, Hardware might not provide enough of a counterbalance to the food business.

CDS Liquor Implementation Uncertain in QLD and WA

The group’s liquor business sales increase by 5.7% to $3.28bn, which is reflected in “increased sales from both existing and new contract customers, and from the annualisation of Porters Liquor which was acquired in 2H17”.

Headwinds related to a new release of Container Deposit Scheme (CDS) currently exist. Under the scheme, consumers can claim back 10 cents per drink container at collection points and reverse vending machines. Each drink producer needs to register for the scheme at a cost of $80 per product. A smaller producer selling a variety of products could end up paying over $3,000.

Businesses were stuck absorbing the price rises to maintain price parity, or lifting prices and losing business, and this is especially harmful to smaller independents cooperating with MTS.

As CDS has already rolled out in NSW, SA and NT, QLD and WA are the next states to implement the act. The Queensland government announced that the state will start an initiative in July 2018 while Western Australia will commence in 2019. The true cost may be a new government tax on consumers of between $4 and $5 per carton, as retailers and suppliers are likely to begin increasing their prices to build the deposit refund float.

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Metcash Shares EPS decreased by 23.2% from 2016 to 2017

Earnings per share decreased by 23.2% from FY16 ($23.3) to FY17 ($17.9), which represents a diminished performance compared to Woolworths (ASX WOW) and Wesfarmers (ASX WES) -5.1% and 603.6% respectively.

Metcash shares have suffered a continued decline from May since Metcash terminated the relationship with Drakes Supermarkets and wrote down 30% of the food and grocery asset base for $350m. The recent share buy-back could be intended for stronger EPS performance.

The company’s net profit margin (1.23%) is lower than that of WOW (2.86%) and WES (4.22%), which mainly results from the lower revenue of Metcash shares. In FY17, the return on equity (ROE) ratio of MTS is 10.6%, the worst among the three players.

In addition, the public holds a low expectation of Metcash shares. Its price/earnings ratio stands at 13.45, compared to 22.16 (ASX WOW) and 37.03 (ASX WES). In terms of price-to-book ratio, MTS (1.66) could be undervalued as it is lower than WOW (3.73) and WES (1.93).

Metcash Business Model Is Uncertain

Metcash business model is under doubt. Against the backdrop of food market competition and deflation, the margin earned by the business is falling. The consistency of the IGA supermarket offering is proving difficult to control.

Drakes’ moving into self-supply could indicate the start of customer exodus for Metcash. Mitre 10 and Home Timber and Hardware attract more trade customers instead of retail customers. The prospect is gloomier with liquor group CDS with their future plans still uncertain in QLD and WA.

Metcash needs another growth business to sit alongside food, hardware and liquor for MTS stock to see any upside in the near future.

Are you looking for more stocks to buy? In our opinion, buying the right stock at the right time is just half the battle – knowing how to manage the position and risk is just as, if not more important. Take our free 5-day trade like a professional course, it give you the foundational knowledge required to become a profitable trader.

This is general advice only. MF & Co Asset Management has not considered your personal financial needs, objectives or current situation. This information is not an offer, solicitation, or a recommendation for any financial product unless expressly stated. You should seek professional investment advice before making any investment decision.

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