Metcash Surprises

This story features METCASH LIMITED. For more info SHARE ANALYSIS: MTS

Brokers were pleasantly surprised by Metcash’s result, but FY24 is shaping up with several challenges.

-Revenues weak but Metcash's margins surprise in FY23
-Food market share holding better than expected
-Hardware supported by trade sales
-Costs a problem

By Greg Peel

Metcash ((MTS)) posted a solid FY23 result, well received by the market, with all divisions ahead of consensus on strong margins offsetting revenue weakness. Earnings margins were more resilient than expected due to cost savings and investments by retailers and suppliers.

Food sales nevertheless fell slightly in the second half and given food inflation running at 7.6%, volumes were materially lower. IGA supermarkets were a major beneficiary of covid lockdowns given the requirement to shop local and it was always assumed this trend would normalise post covid.

The challenge for IGA is an increasing shopper focus on price amidst the high cost of living. This has sent more shoppers towards Aldi, but as UBS notes, Metcash’s result suggests not all of Aldi’s market share gains have been from independents.

Although food margins have been well managed, Citi believes they have likely peaked given the impact from Victorian tax increases, moderating food inflation and other cost pressures rising. This broker sees margins normalising over the next few years. But Jarden points to earnings tailwinds in the form of a lower tobacco mix, the return of the tobacco excise and the cycling of high supply chain costs and terms.

For the first seven weeks of FY24, food trade was up 6.8%, which suggests market share is holding, Macquarie notes, but then inflation is running at 8%.

Hardware

Trade sales for hardware were up 3.8% in FY23 but DIY sales only 0.6%. Independent Hardware Group sales were up 2.7% and Total Tools up 4.8%. Trade sales were supported by a continued pipeline of construction activity, but DIY is expected to remain under pressure, again due to cost pressures on consumers. DIY was also popular during lockdowns.

Total Tools saw a 20% increase in sales in the first seven weeks of FY24 but this was due to acquisitions, with like-for-like sales flat. IHG sales continue to be dampened by member de-stocking. The shift for Metcash to add joint venture and corporate Total Tools retail will be margin dilutive, Goldman Sachs warns, due to margins being below franchisee and exclusive label businesses.

Jarden suggests, despite cycle headwinds, Metcash should benefit from a lift in Total Tools JV stores, and a normal ordering cycle and mix (trade versus DIY) through FY24.

Costs

Metcash’s largest operating expense is wages, which grew 10% in FY23 and increased to 5% of sales. Goldman Sachs remains concerned wage inflation will result in margin pressure. The cost of doing business was also higher in FY23 due to Victorian payroll/workcover and overheads.

Interest costs were materially higher, on a combination of floating debt and capital expenditure. Interest cost and cost of doing business largely offset better food market share, Macquarie notes.

Outlook

UBS was the only broker covered daily by FNArena that went into the result with a Buy rating and that is unchanged, although the broker’s target has fallen to $4.50 from $4.75.

Macquarie, Citi and Ord Minnett remain on Hold (or equivalent) albeit Ord Minnett is yet to update on the result. Macquarie has retained its $3.90 target while Citi has cut to $4.00 from $4.30.

Not covered daily, Jarden believes Metcash screens as more defensive than cyclical and the broker retains an Overweight rating, which is one notch below Buy on Jarden’s five-tier rating system. The target is trimmed to $4.30 from $4.40.

Goldman Sachs is on Neutral, but has bucked the trend by increasing its target to $3.70 from $3.50.

Metcash’s forecast FY24 dividend yield (among daily brokers) is a healthy 5.4%.

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