Metcash’s Earnings Geared To Housing Recovery

Australia | Dec 04 2024

Having set the stage with downgraded earnings expectations, Metcash's first half earnings results delivered some welcome surprises.

-Metcash's H1 performance not as bad as feared
-Hardware disappoints but shows green shoots
-Food delivers a margin boost 
-Liquor boosts market share, shame about the margins
-What the broker's think

By Danielle Ecuyer

Housing has the potential to unlock earnings leverage

Post Metcash's 1H25 earnings guidance downgrade at the end of October, investors likely breathed a sigh of relief when the actual results came in as expected, approaching the upper end of management's downgraded guidance.

The tough trading conditions marking FY24 results continued into 1H25, with the hardware division, representing around 30% of earnings, squarely in the eye of the housing storm, or more precisely: feeling the lack of activity.

Macquarie noted the "key disappointment" for Metcash came from hardware, with like-for-like sales falling -5.6% over the previous corresponding period. The decline accelerated from -2.7% in FY24 results and was worse than expected.

The falling cycle has directly impacted the operating leverage for the hardware division, with earnings before interest and tax margins slipping around -110bps to 5.1% from 1H24.

As UBS highlights, the hardware division is the "most cyclical" of Metcash's three divisions, including food as the largest segment at circa 44% of earnings, and liquor at around 26%.

Trading activity impacting hardware has softened in each of the recent updates, including the company's AGM on September 13 and the guidance downgrade on October 25.

Following successive downgrades in 2H24 and 1H25 guidance for Total Tools and Metcash's Independent Hardware Group, J.P. Morgan remarks there are some positive signs emerging. UBS confirms Metcash has indicated the rate of decline in trade has "steadied" since October 25, while the pipeline for frame and truss orders has extended.

Macquarie is less convinced by the idea of green shoots appearing in the beleaguered housing sector, with the analyst stressing uncertainty around whether the building cycle has bottomed. Weak housing indicators continue to suggest an "anemic market."

Citi also weighs into the housing/hardware debate, believing exposure to small and medium businesses means the division is most exposed to the detached housing market and sees this as a potential "driver of demand."

The Citi analyst explains private sector detached housing approvals bottomed in the March quarter this year and have progressed to a rate of circa 9,600 per month in September, around the 10-year average.

Detached private sector housing starts appear to have bottomed in the June quarter, aligning with the typical three-month lag between approvals and starts in the industry.

Citi is upbeat on the outlook for hardware and expects momentum in the private sector dwelling market to ramp up toward the end of FY25. The broker forecasts around 9% growth in hardware earnings for the current fiscal year.

Morgan Stanley gleaned from the earnings call that management is experiencing an uplift in demand for frame and truss, with a positive "lengthening of the pipeline."

Ord Minnett also believes the hardware division is well-positioned for a recovery when the RBA cuts interest rates.

Goldman Sachs, in contrast, is more circumspect regarding the hardware division. This analyst highlights a -3.7% decline in sales for the independent hardware group, excluding the Alpine and Bianco acquisitions, compared to a year earlier.

Home improvement advanced 0.5%, while retail scan sales from 358 stores fell -1.2% in the do-it-yourself segment and -9.2% in trade, compared to positive sales growth reported by Bunnings at the Wesfarmers ((WES)) AGM for 1Q25 in both segments.

Supermarket sales held up despite tough conditions

Metcash's largest earnings contributor, food, reported sales growth of 10% year-on-year, boosted by the Superior Foods acquisition, volume growth for wholesale, and price inflation, Macquarie details.

Compared to 1Q25 sales growth for Coles Group ((COL)) at 2.4% and Woolworths Group ((WOW)) at 2.3%, IGA sales rose 2.2% excluding tobacco.

Macquarie highlights Superior Foods is winning new customers. UBS concurs with Macquarie, pointing to strong sales growth of 6.1% since Superior Foods became part of Metcash on June 3, 2024, although earnings margins came under pressure in 2Q25.

J.P. Morgan commends Metcash for managing costs well in a challenging operating environment, evidenced by a lift in supermarket and convenience margins by 12bps to 2.27% in 1H25. This broker highlights a greater annual margin uplift for underlying supermarket margins by 22bps to 2.79% once tobacco, convenience, and joint venture earnings are excluded.

Macquarie's observations around tobacco reveal a decline in sales of -16.5% against 1H24, with tobacco representing around 19% of total food segment sales compared to around 25% in 1H24.

Management highlighted tobacco is a very low-margin product, accounting in part for the improvement in the food division's margins.

Ord Minnett and Morgan Stanley also observed food and grocery earnings margins came in better than expected, which was viewed as a positive result.

Moderating inflation has also boosted volume growth, according to Morgan Stanley.

Chasing liquor volumes depresses margins

Turning to the liquor division, Metcash has benefited from growth in market share for independents in the retail space. J.P. Morgan highlights off-premise and contract customers grew by 2.4% in 1H25 and 5% in November.

The results exceeded those from Endeavour Group's ((EDV)) retail sales, which rose 0.8% in 4Q24 and 0% in 1Q25, and Coles Liquor, whose annualised sales slipped -0.4% in 4Q24 and to 0% in 1Q25.

Management's decision to focus on volume growth came at the expense of margins in liquor, which fell by -10bps year-on-year to 1.9%.

Macquarie flagged liquor earnings were below estimates by -7% and expects a further contraction in margins by -16bps to 2% for FY25.

Regarding costs, management reiterated -$15m in cost savings, Goldman Sachs notes, while also providing updated capex guidance for Project Horizon. Macquarie points to 1H25 capex of -$71m, with FY25 guidance at -$205m, below the previous guidance by -$30m, partly due to delayed spending.