Metcash’s acquisition of Superior Foods and two mid-sized hardware businesses is sensible and, in our view, best described as fairly priced. The upside in value for Metcash shareholders will come from realisation of synergies by FY26e, with potential value creation as Metcash builds scale in the foodservice and frame & truss sectors.
Metcash reported a soft 1H24 result with sales up 1.3% and EBIT down 3.4%. The drop in EBIT was concentrated in the Hardware division and further margin pressure is likely given soft demand and rising operating costs. The Food segment has once again confounded sceptics by growing sales (ex tobacco) close to market growth and liquor is performing well. Metcash’s significant capex and acquisition outlays along with rising rates will lift finance costs over the next 18 months.
Metcash has announced the put option on the remaining 15% of Total Tools Holdings was exercised. The rapid increase in valuation of Total Tools highlights what a well-timed acquisition it was. The initial 70% stake was at an enterprise value of $81 million and this final 15% is at an EV of $677 million. While relatively small, the accounting for Total Tools will result in 2.7% EPS dilution on our estimates from this additional stake. Metcash’s Hardware division accounts for 49% of our enterprise value and the success with Total Tools is a key plank of that. We have a Buy rating and $4.50 target price.
Metcash reported FY23 EBIT up 8% and 2H23 EBIT up 5%. While there has been some concern about a drop in demand, Metcash has demonstrated good sales trends relative to industry growth in all its segments. The company may not buck broader industry trends going forward, but its valuation provides a margin of safety relative to peers.
We expect a strong year of earnings growth for Australian supermarkets in FY23e. Higher food inflation is boosting sales and gross margins are also rising. We lift our FY23e EPS forecast for the major chains. Woolworths has the strongest sales growth, followed by Metcash, then Coles based on our feedback. In the full report, we address the cycle of price inflation and outlook over the next 12 months; and the outlook for Coles and Woolworths gross profit margins and EBIT margins.
Metcash reported FY22 sales of $17.4 billion and EBIT of $472 million. Adjusting for the 53-week in FY22, sales rose 4% and EBIT rose 16%. The results reflects higher price inflation across all divisions and a mix-shift towards the Hardware division, which has higher margins. Metcash has been able to hold onto much of its customer gains made during COVID-19. While we expect a lack of EPS growth over the next two years, the company’s competitive position has improved in each division.
We expect the stock to perform well as the market better understands the benefits Metcash has from higher inflation, the fundamental improvement in its Food market share and multiple revenue drivers in Hardware. Metcash’s market share in grocery has been stable since 2018, a function of its retailers’ better relative price position and less aggressive store openings by rivals. In its Hardware segment, Metcash will benefit from Total Tools store rollout as an offset to a cyclical industry-wide decline in late FY23e.
Metcash reported 1H22 EBIT up 14%. The growth was driven by a full-period contribution from Total Tools in Hardware. Total Tools still has a runway for further growth given imminent store acquisitions. The company has also fundamentally stabilised its market share in Supermarkets. Metcash has a much better business mix and industry structure than historically and as a result the shares should trade at a higher multiple.
Metcash has stabilised its food market share over the past two years and Hardware sales and earnings are likely to grow meaningfully. Metcash is perceived as a COVID-19 beneficiary and therefore has struggled to re-rate in recent months. However, our analysis suggests that its market share in Supermarkets is likely stabilised for more fundamental reasons. Competitors are opening fewer stores, IGAs are no longer shutting stores and the risk of contract losses is now in the rear vision mirror. In the hardware industry, Metcash is likely to gain share given its 60% skew to trade and continued rollout of Total Tools stores.
We have a positive outlook for both revenue growth and profit margins for Coles, Metcash and Woolworths. Higher food inflation is likely to show through and offset the pressures from lower population growth and lapping COVID-19 induced sales growth. Higher inflation is not simply transitory, but has been evident since 2019. The market structure in both supermarkets and liquor add to the investment appeal. We also see a strong recovery for Endeavour Group and can make acquisitions in Hotels.
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