What Does Aldi’s Growth Mean For Metcash?

This story features METCASH LIMITED, and other companies. For more info SHARE ANALYSIS: MTS

-Aldi will weigh on market share
-Independents appear to be coping
-Metcash supporting the sector
 

By Eva Brocklehurst

In the wake of Aldi's incursion into South Australia, which commenced last month, Metcash ((MTS)) and its independent grocery retailers appear to be holding the new entrant at bay. Aldi is expected to move into Western Australia later this year.

While early days, Citi does not expect Aldi's success to do much more than remove 1.0% of annual sales from the Metcash group. Metcash supplies a variety of retailers in Adelaide but its network remains quite intent on closely meeting customer needs and emphasising the fresh component of their offering.

Metcash supplies Foodland and IGA stores with food & grocery, liquor to the Cellarbrations outlets and hardware to its Mitre 10 network. South Australia is an important state as Metcash has a higher food & grocery market share here compared with the national average.

Aldi is instigating a rise in price discounting across the sector, thereby reducing industry margins, Ord Minnett observes, but Metcash provides a broad role to its retailer network, as a box mover with significant sales and in-house purchasing functions as well as store refurbishment programs.

Brokers toured Adelaide stores recently and evaluated the specific efforts being made to improve the offer to customers in advance of Aldi's presence. They note these efforts appear to have gained some traction.

While market share losses and price investment are occurring, and this should likely weigh on sales growth and gross margins, Ord Minnett suggests all the losses are not likely to accrue to Metcash but rather be spread across existing market share. In other words, Coles ((WES)) and Woolworths ((WOW)) will also wear some of the impact.

Moreover, the broker believes the expansion of Aldi has been well incorporated into market estimates. Ord Minnett notes that initial price discounts by Aldi were significant, but the impact is moderating as the level of aggression in price is cooling.

Deutsche Bank observes that whilst there are only eight Aldi stores currently in operation in SA, the launch has been intensively marketed. The worst declines for the IGA stores was in the first week before moderating somewhat.

The visit served to remind the broker that independents have a strong position in SA, with the Foodland brand resonating will with consumers. This should position them well to defend against Aldi's roll-out in that state compared with the eastern seaboard.

Still, while the impact from the initial stores may settle down, the roll-out of Aldi will be rapid and this could worsen the decline. The broker believes Metcash has been obtaining a benefit from the struggles at Woolworths and this is likely to eventually turn into a headwind.

As an addendum to the SA site tour, Deutsche Bank notes some discussion around the potential for a merger between Mitre 10 and Home Timber & Hardware. Metcash management believes there a distinct complimentary fit in this, as well as potential to improve the operations of Home Timber & Hardware as it has lower margins than Mitre 10 stores.

Also, Deutsche Bank notes, the implementation of the effects test, as recommended by the Harper Review and endorsed by the government, could allow the courts to decide how much a retailer's conduct increases competition versus any lessening. It remains unclear whether this effects test will be passed by parliament but, on balance, this could be positive for Metcash and could make in harder for Coles and Woolworths to open new stores, the broker maintains.

Credit Suisse also does not expect the impact of Aldi to be a significant drag. The broker believes the independents' approach has been well thought out, strengthening their position in fresh food, refurbishing stores and elevating service levels. Nevertheless, experience in the eastern states suggests to the broker that the impact on customer traffic becomes more negative as Aldi's network increases.

There appears to have been some aggressive pricing by Aldi, particularly in regard to produce, and this has had a consequent impact on retailer profit. Credit Suisse believes this is a long-term issue for both the retail sector and Metcash.

The broker expects the negative sales impact will accelerate in FY17 but Metcash appears to be willing to support the sector through better costs, which suggests that wholesale deflation will accelerate.

There is no average store in the sector, making generalisations difficult, the broker adds. While upgrading to premium stores is working for some, the broker does not believe this is the panacea for all. Credit Suisse maintains Metcash could do more to align pricing with the requirements of the value stores.

There are two Buy, three Hold and two Sell ratings for Metcash on FNArena's database. The consensus target is $1.61, suggesting 8.0% downside to the last share price. Targets range from $1.05 (UBS) to $2.05 (Citi).

Note also that Metcash is, according to the most recent ASIC data, the second most shorted stock on the ASX at 17.6% [See The Short Report].

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms