Healthy Growth Rates Can Continue For Metcash




As Australia's population travels to domestic and rural destinations for recreation over the summer break and there are more people working from home, all segments of the Metcash ((MTS)) business are expected to grow at healthy rates.

In FY21 the company will also cycle a previously negative year, given the impact of bushfires on regional stores where the company's IGA supermarket network prevails. Food sales grew 9.5% in the first half, with growth in both transactions and basket sizes. The earnings (EBIT) margin for supermarkets improved to 2.1% because of leverage from higher volumes.

Liquor sales were up 14.3% as the demand from retail outlets more than offset the restrictions placed on pubs and bars. Underlying wholesale food sales ex-tobacco increased by 16.3% with underlying earnings up 39%. Hardware sales were up 20.6%.

Macquarie notes cash flow was extremely strong in the first half, at $315m, and envisages strong growth across key categories, but becomes more cautious about the sales trajectory as a vaccine is rolled out nationally.

UBS downgrades to Neutral from Buy, as catalysts to the upside have played out, although acknowledges the pandemic has structurally benefited Metcash through the shopping-local theme and increased at-home consumption.

A moderation in food sales in November and into December probably signals the end of large market share gains for independent grocers and Citi suspects moderation is occurring faster than the broader market, amid a reduced tailwind from the focus on local shopping.

Credit Suisse agrees sales growth has now decelerated from the above-trend rate that was experienced in the first half yet there is a strong likelihood that food sales for Metcash are simply turning into a low rate of growth from an historical low single-digit decline.

The IGA store network appears to be stabilising and refurbishments – and the resultant positive customer response – are likely to continue because of tax incentives. The food distribution business is also now more sustainable. In liquor the network is growing and the broker suggests the company's position is under-appreciated, with a clear store network advantage in convenience liquor.

Ord Minnett also considers Metcash benefits from a robust food retail industry as inflation is occurring and competition, while aggressive, is not irrational. The broker also considers private label a source of future earnings margin for liquor with a trend to off-premises consumption a positive for Metcash.


The trend to DIY in hardware is also expected to endure and trade momentum should improve with the government's HomeBuilder incentives. Citi observes hardware is now the medium-term growth driver, facilitated by the Total Tools acquisition (70%).

The broker estimates a fully consolidated Total Tools will contribute earnings of $41m in FY22, assuming 24 joint venture stores by April 2022. This growth will require additional debt funding and is not reflective of the underlying ownership interest.

On Citi's estimates, Metcash will take around 50% of system profitability. Morgan Stanley considers the upside associated with hardware is increasingly evident, noting sales growth was also complemented by margin expansion in the first half.

Credit Suisse, too, has no doubt Total Tools benefitted from a high level of expenditure on tools during the pandemic. Hardware Click & Deliver has been added to Victoria and Tasmania and a nation-wide roll-out is to be completed in the second half.

UBS envisages around 3% earnings growth in hardware, or around 11% including Total Tools, amid upside from an improved housing backdrop.

Capital Returns?

The broker also considers it likely capital returns can be delivered, given around $120m in net cash is available. Citi assesses the company's balance sheet is well-positioned to make accretive acquisitions in hardware, or return capital to shareholders.

More than 80 basis points growth in market share occurred during the pandemic and UBS believes the company is positioned to retain some of the gains because of improved pricing and refurbishments.

That said, there is competition from the shift to online as well as the bigger supermarkets rolling out "local" stores. The independent sector has acknowledged a need to catch up in online food sales.

Despite category and company-specific benefits from the pandemic and further diversification in hardware, as well as a strong balance sheet, Morgan Stanley notes the stock trades at a -40% discount to the S&P/ASX 200 industrials ex financials and suggests this discount is too steep.

FNArena's database has four Buy ratings and two Hold. The consensus target is $3.88, suggesting 9.2% upside to the last share price.