Brokers note an improving sales trend in food over the first half for
-Food earnings improve, assisted by reduced deflation
-Still a risk independent supermarkets may defect to Drakes
-Citi considers cash-flow yield less attractive because of earnings volatility
The outlook for grocery and hardware wholesaler Metcash ((MTS)) is improving, although the negative impact from the loss of the Drakes and 7-Eleven contracts, and the prospect of renewing the FoodWorks contract, will weigh on the stock in FY20.
Underlying net profit was
While cash flow was weak, and the main disappointment for Morgan Stanley, a reintroduction of some working capital should mean a recovery from FY21. Beyond this, an uplift in inventory should provide earnings leverage as food deflation moderates.
Morgan Stanley forecasts a -4% decline in earnings in FY20 with a -7% decline in food earnings. Excluding the impact of the loss of the Drakes contract and lower provision releases, earnings growth of 4%, similar to the first half, is expected.
Macquarie is yet to find evidence that food earnings have reacted positively to the to the investment in operating expenditure. As a result of the decline in earnings, margins contracted by -20 basis points to 1.9%. What pleased the broker was that the grocer group, IGA, like-for-like sales were up 0.4%.
However, there remains a risk with this grocery chain, as the number of those with the IGA banner are declining. There were 10 net closures of IGA stores over the half, although the company expects net openings in the second half. There is also a risk, Macquarie adds, that independent supermarkets could defect to wholesaler Drakes. Drakes has indicated it has been approached by independents but has to prove it will be cheaper.
Uncertainties
What is uncertain, in Credit Suisse's view, is a longer-term understanding of what the loss of Drakes and 7-Eleven contracts mean for the
Although supermarket wholesale sales, ex tobacco and contract losses, did grow in the first five weeks of the second half, the broker is not sure that
Under its Mfuture program,
Capital expenditure is expected to rise as this program ramps up over the next 12 months. Citi estimates capex of
Ord Minnett is more positive and upgrades to Accumulate from Hold, as valuation support has emerged and there is an improving sales trends in food. Wholesale sales, excluding tobacco, are now growing and the competitive dynamics in grocery retailing are more rational, so the broker is confident that the FoodWorks contract can be maintained.
Hardware
Significant synergies were realised in hardware,
The company believes it is not losing share in tradies, despite the push by Bunnings ((WES)) into the category. Metcash acknowledged some competitors were experiencing reductions in sales in line with the fall in housing approvals but pointed out DIY is performing well. Macquarie notes
The company continues to increase the focus on fresh food, intending to complete its trial of Kitchen Pantry by the end of FY20.
The broker welcomes the investment in online but notes this is a highly competitive market and IGA is moving slowly. Macquarie also believes, despite suggestions to the contrary, that Amazon is unlikely to partner with
FNArena's database has it all, two Buy, two Hold and two Sell ratings. The consensus target is
See also, Metcash Under Scrutiny After Losing 7-Eleven on
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