Australia | Aug 07 2007
By Chris Shaw
Coles Group (CGJ) and the proposed takeover by Wesfarmers (WES) to a lesser extent the potential for Woolworths (WOW) to gain from its rival’s underperformance have dominated headlines in the retail sector over the past few months, but a tour of the Western Australian operations of Metcash (MTS) appears to have reminded analysts of another attraction in the sector.
According to Merrill Lynch, which rates the stock as Buy with a price target of $5.30, Metcash shares at current levels are simply mis-priced and this presents a buying opportunity for investors.
In the broker’s view the earnings risk for the company remains to the upside, not only given management guidance appears very conservative but because the company has significant exposure to the still strong WA economy and is benefiting as Coles struggles, something that could continue for some time.
This leaves the company well-placed to generate double-digit comp store sales growth for the next few years, with upside from the potential to expand its Fresh offering and improvements in its supply chain.
GSJB Were also sees scope for upside in similar areas, suggesting there is potential for the company to expand its customer’s wholesale purchases by extending its fresh food distribution operations and by continuing to invest in its stores.
There are signs this expansion in the fresh food sector is already occurring as the broker notes since the Foodland acquisition in 2005 the company’s fresh food distribution business has grown from 14 to 63 customers.
While expanding this Australia-wide would be a difficult undertaking given existing customer contracts and other issues there is potential for success in the broker’s view, particularly as it sees scope for the company to offer potential customers some cost savings, so increasing margins.
Additional growth could also be achieved via acquisitions as the broker points out the company has a strong balance sheet and so can consider some bolt-on expansion options. This adds up to the stock offering good value at current levels as on its numbers Weres estimates the stock is trading on a 10% discount to the FY08 All Industrials ex Banks average P/E (price to earnings ratio), which compares to its historical discount of 2-5%.
Citi offers the same argument in support of its Buy rating as the broker estimates the stock is trading on a prospective FY08 P/E of around 15.7x compared to the All Industrials at more than 18x, while in comparison to Woolworths the stock is at a discount of 20%.
Earnings forecasts for the stock are little changed following the tour, with Citi the most bullish in forecasting earnings per share of 24c this year, 28c next year and 32c in FY09 compared to Merrill Lynch at 23.1c, 26.1c and 29.4c respectively. According to Thomson One Analytics the median earnings estimates for the company are 23c, 27c and 30c.
Thomson One shows a median price target of $4.90, while the FNArena database shows an average price target of $5.15. Overall the database shows the stock as being rated Buy four times and Hold five times.
Shares in Metcash this morning are higher in a stronger overall market and at 11.30am were up 9c at $4.39.