Australia | Nov 30 2009
This story features METCASH LIMITED, and other companies. For more info SHARE ANALYSIS: MTS
By Chris Shaw
Metcash ((MTS)) reports interim earnings this week and Citi expects a net profit of around $113 million for the six months, a result that would be towards the top end of guidance from management of earnings per share growth of between 7-10%.
But the profit result has quickly been replaced as the major point of interest for Metcash as the company last week announced it was bidding to acquire 50.1% of hardware group Mitre 10, with Citi estimating the company is likely to pay something between $30-$50 million for the stake if the proposal is successful. The proposal has an option for Metcash to acquire the balance of Mitre 10 at a later date.
This suggests a good price if the deal goes ahead, Citi estimating on a price-to-sales ratio the Metcash purchase would be at a significantly lower price than Woolworths ((WOW)) paid for its stake in Danks.
Why the move is attracting such attention is Citi’s view Mitre 10 could become Metcash’s fourth business pillar and one offering good growth potential from the scope to consolidate the hardware market and the wholesaling side of that market in particular. The current industry structure highlights this, as while Bunnings has around 20% of the market and a combined Bunnings/Woolworths is likely to have around 27% by 2015 there remains significant scope for further consolidation among the other players.
Credit Suisse suggests if the Mitre 10 move is successful it is likely to be a 5-year process for Metcash in turning around the business, with scope for value creation of around 10-20% of Metcash’s current enterprise value on its numbers over such a period.
Any value creation in Credit Suisse’s view is likely to be centred on Metcash’s ability to lower sourcing costs, which would in turn improve the competitiveness of the independent retailers. The timing of the move is good according to RBS Australia, while the broker also sees the proposal as logical as turning around Mitre 10 would play to the strengths of Metcash given its expertise in wholesale operations.
On its numbers the deal should be slightly earnings per share accretive by year two assuming debt funding and around $5 million in synergy savings, but like Credit Suisse, RBS Australia suggests any significant turnaround in Mitre 10 will take some time and require a reasonable level of investment, which adds some execution risk to the move.
To reflect these risks, RBS Australia retains its Hold rating on Metcash, one matched by GSJB Were who also updated its view on the stock post the announcement of the Mitre 10 proposal. In contrast, both Credit Suisse and Citi have Buy ratings, while JP Morgan retains its Underweight recommendation.
In JP Morgan’s view Mitre 10 may be able to improve financial performance at Mitre 10, but with competition in the sector increasing there is potential the company may need to pass on to customers some of the benefits it generates from running the assets better, meaning delivery of financial benefits from the move is anything but certain.
As well, JP Morgan remains concerned over the potential for independent grocers to continue to lose market share, which would impact on Metcash’s core earnings, while the broker also sees scope for a redistribution of system returns away from the company to store owners.
JP Morgan is the only one in the FNArena database so negative on the Metcash outlook, as aside from its Underweight recommendation the stock is rated as Buy three times and Hold six times. The average price target according to the database is $4.72, which is up from $4.68 prior to the announcement of the Mitre 10 proposal.
The range of price target is relatively wide, with JP Morgan the lowest at $4.26 and Credit Suisse currently the most bullish at $5.20. This reflects its earnings per share forecasts of 31.8c for FY10 and 34.6c for FY11, while consensus earnings per share forecasts according to the database stand at 32.2c and 35.1c respectively.
Shares in Metcash today are higher and as at 11.00am the stock was up 6c at $4.62, which compares to a trading range over the past year of $3.80 to $4.74.
Click to view our Glossary of Financial Terms
CHARTS
For more info SHARE ANALYSIS: MTS - METCASH LIMITED
For more info SHARE ANALYSIS: WOW - WOOLWORTHS GROUP LIMITED