Housing Crunch For Metcash

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While Metcash has enjoyed resilient food & liquor sales, hardware has been hit by the building downturn. Analysts nevertheless see brighter times ahead.

-Metcash earnings down, but better than expected
-Food & liquor sales holding up
-Hardware hit by a slowing in builder confidence
-Housing cycle expected to turn in 2025

By Greg Peel

Metcash ((MTS)) this week reported its FY24 result, which showed a -1% drop in earnings year on year. The result was nevertheless 2% better than the consensus forecast, and a solid result, analysts declared, in a challenging environment.

Total food sales (ex tobacco) rose 4.6%, as the group benefited from investment in store competitiveness. Food inflation moderated to 1.9% in May. Strong food sales continue to be offset by softness in tobacco sales, which fell -14%.

The growing popularity of vaping, and the growing availability of illegal cigarettes (under the counter at some convenience stores and tobacconists, along with illegal nicotine-based vape liquids), remain a headwind for compliant operators like Metcash. Further regulation and tightened policing of illegal tobacco and vaping could stem this revenue headwind for Metcash, Macquarie posits.

An announcement from the government that vapes will soon only be available in pharmacies, and to adults, has since been forthcoming.

Despite a solid result in food, Citi believes independent supermarkets continue to cede market share, principally to Aldi and Coles Group ((COL)). While continued strong cost management is welcomed, Citi sees limited further upside to margins over the next few years.

Goldman Sachs has been cautious on its outlook for Metcash versus consensus expectations, with one reason being intensifying competitiveness in supermarkets, especially given the onset of Ocado from Coles may result in market share losses in FY25.

A recent Choice survey found the same basket of groceries at Aldi was -25% cheaper than at Coles or Woolworths Group ((WOW)). IGA stores were not surveyed given their independence, with stores setting their own prices. Apples would thus not be apples.

Goldman Sachs’ latest channel feedback suggests while the multi-site IGA supermarkets are holding share well, the tail of smaller-format independents are beginning to see more share losses given a higher price gap to the majors.

Liquor was Metcash’s strongest division relative to expectations. The company noted it was winning share overall, but was seeing on-premise sales slowing. Macquarie sees medium term upside through expansion of liquor sales into recently acquired Superior Food. The first seven weeks of FY25 trading saw sales up 3.1%.

But food sales (including tobacco) were down -1.7% in the first seven weeks, as they were in FY24 in total.

The Hard Part

Hardware is the most cyclical Metcash division, and is estimated to now represent more than 50% of the stock’s value. The hardware division is divided into the Independent Hardware Group (IHG), which includes the Mitre 10 and Home Timber & Hardware chains, along with a couple of smaller chains plus a number of pure independents, and the previously acquired Total Tools chain.

IHG and Total Tools are more trade-oriented than Bunnings ((WES)), and trade is experiencing a more cyclical decline than DIY.

Australia’s housing construction backdrop is challenging, notes UBS, with the overall market down -6% (new housing -14%, renovations -3%) and DIY flat (with notable weakness in more discretionary items like outdoor furniture or a new mower).

Metcash noted a “rapid slowing in builder confidence” was negatively impacting demand for hardware. What’s more, Metcash was seeing intense competition in tools as Tool Kit Depot pushes for online growth, but stated this competition had eased in recent weeks.

The Tool Kit Depot was formerly Adelaide Tools, rebranded when acquired by Wesfarmers (Bunnings).

There is a twist for Metcash as the rapid, and profitable, growth of the company-owned Total Tools stores was dragging on margin, as the stores are lower margin than pure franchisee fees. Yet, Macquarie sees this growth as positive overall. Management noted the first seven weeks of trading saw 0.6% growth, helped by the recent Alpine Truss and Bianco Construction acquisitions.

Yet, total hardware revenue and earnings fell -3% and -11% respectively in FY24, excluding acquisitions. Trade represents two-thirds of revenue and continues to be impacted by the downturn in the residential construction cycle. With housing approvals for the twelve months to April down -10% year on year, conditions are likely to remain tough into FY25, Citi warns.

And you thought there was a housing crisis.

And Another Thing

There is little room on the Metcash balance sheet for capital management. With a challenged housing market biting, and cost of living pressures impacting on supermarkets, Metcash is also faced with the realities of higher interest rates.

Indeed, interest costs are flagged to step up a full 32% in FY25 to $120-125m, up from $93m in FY24, as higher rates, acquired leases and debt-funded acquisitions push up funding costs.

All is not Lost

Looking ahead, Jarden continues to see value in Metcash, given significant operating leverage across hardware “when the housing cycle turns into 2025”. Nearer term risk does nevertheless exist, particularly across the frame & truss businesses, Jarden suggests.

The broker is increasingly confident in Metcash’s ability to grow food & liquor earnings via ongoing cost-outs, rising teamwork scores and mix (food own-brand was up 16% in FY24). Jarden retains an Overweight rating with the view valuation is attractive, the food market is improving, and the market will begin to price in a housing up-cycle three to six months in advance.

Jarden increases its target to $4.40 from $4.20.

Goldman Sachs has been cautious on its outlook for Metcash given a higher exposure to trade in hardware, intensifying competitiveness in supermarkets, and recent high management turnover. This broker believes execution demonstration is required to turn more constructive.

Goldman maintains a Neutral rating with a $3.70 target.

While earnings growth has been modest in the food business, it nevertheless has been better than Evans & Partners’ expectations, and Metcash has held onto its material step-up in underlying profitability compared to pre-covid levels. Given this, and recent share price underperformance, this broker upgrades to Neutral from Negative with a valuation of $3.93.

While underlying earnings for the hardware business are likely to remain challenged in the near term given weak operating conditions, recent acquisitions are expected by Evans & Partners to underpin overall modest group earnings growth.

Among brokers monitored daily by FNArena, Citi cites no room for capital management and challenging market conditions as reasons to stick to Neutral and a $4.00 target.

Morgan Stanley has dropped its target to $3.83 from $4.03 in line with its divisional earnings adjustments, and retains Equal-weight.

Ord Minnett is claiming bottom-of-the-cycle earnings. Predicting the length and depth of the housing cycle is challenging, the broker admits, but Metcash’s investments in new businesses, the Total Tools store rollout, and tight cost control position it well for the future.

Ord Minnett sees valuation as attractive, given the long-term opportunity the investments in hardware present, upgrading to Buy from Accumulate with a $4.30 target.

UBS also retains Buy, given resilient food & liquor divisions and growth potential in hardware when the cycle improves. Target cut to $4.00 from $4.25.

Growth opportunities through a wider addressable market in the Superior Foods and hardware acquisitions, alongside increased re-investment into the existing business, has Metcash set up for growth over the medium term, Macquarie believes.

This broker sticks with an Outperform rating, trimming its target by -2% to $4.20.

That leaves three Buy or equivalent and two Hold ratings for Metcash with a consensus target of $4.12.

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