Metcash Outlook: Tobacco Sales vs Rate Cuts

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Metcash’s FY25 result was solid, showing reliance in Food & Liquor. Signs are positive for a recovery in Hardware, but rate cuts are key.

-Metcash FY25 earnings at top end of guidance
-Food & Liquor solid, despite declining tobacco sales
-Hardware set to improve on RBA rate cuts
-Visibility on Hardware’s recovery timing and magnitude remains limited

By Greg Peel

Grocery wholesaler and hardware group Metcash ((MTS)) reported FY25 (year-end April) earnings at the top end of guidance updated earlier this month, and added a positive trading update for the first seven weeks of FY26.

The company posted a solid performance in its key Food division, increasing earnings in the second half even as tobacco sales plunged -23% amid a boom in the illegal tobacco trade. Amortisation charges from the Superior Foods acquisition weighed on the result, but the new business’s underlying operations made a solid showing, Ord Minnett suggests.

Supermarket sales growth ex-tobacco in the first seven weeks of FY26 was a pleasing 2.9%, driven by private labels, more competitive pricing, and refreshed stores.

The hardware division’s second-half performance was better than analysts expected, with a tight rein on costs and much smaller contraction in margins than seen in the first half, while early FY26 sales are up 1.3% on a year ago.

It is a difficult environment for hardware, all agree, but Metcash has set the business up well for any improvement in consumer confidence.

Impressive operating cash flow and reduced capital expenditure meant net debt came in at $577m, well below Ord Minnett’s forecast for $921m. Reduced guidance for capital expenditure in FY26 should drive further growth in cash generation.

Hardware

Metcash’s Independent Hardware Group (IHG) is the largest independent hardware group in Australia, and a leader when it comes to servicing the Trade market.

Mitre 10 is the country’s largest independent network of hardware operators with over 300 stores, servicing retail but with a leaning towards Trade. Total Tools is franchisor to the largest professional tools market in Australia, while Home Hardware is also Trade-focused, along with a handful of smaller operators in the hardware group.

The key positive from the Hardware result, suggests Macquarie, was an improvement in earnings margin, with some 40 basis points of expansion in the second half from the first. This was driven by IHG, with margins up 70bps half-on-half on execution of cost management initiatives.

This compared to Total Tools with -80bps of compression, although management called out improving retail margins through the second half and into FY26. In the near-term, better margins have offset like-for-like sales growth, which remains subdued. The first seven weeks of FY26 saw 0.8% growth for IHG but -2.7% for Total Tools.

Longer-term, Macquarie has lifted its Hardware earnings forecasts as cost efficiencies are set in the base and the top-line improves alongside housing conditions.

Housing conditions remain somewhat of a sticking point.

Hardware network sales and earnings were broadly flat in FY25, suffering higher D&A expense due to acquisitions. These businesses have been a source of underlying sales and earnings declines due to subdued trade activity and cost of living pressures, UBS notes.

IHG has shown signs of improvement since the fourth quarter, while Total Tools’ momentum remains subdued. Looking forward, UBS suggests lower interest rates should support trade activity and ease cost of living pressures, with operating leverage for retail and wholesale a driver of forecast earnings margin expansion.

Citi is not so confident.

Detached housing approvals are up around 5% year on year into the March quarter, but the recovery is not as strong as Citi expected when it upgraded Metcash to Buy last December. Given the typical lag to housing starts of approximately three months, a more meaningful volume recovery for Metcash’s businesses does not look likely to Citi until FY27.

Given this, and with earnings still down year on year in the second half, Citi is concerned the market’s 13% earnings growth forecast for FY26 looks optimistic.

Citi notes Bunnings’ ((WES)) expanded Tool Shop (expected to be in around 190 stores by end-June) is likely to take some market share over time.

Management sees limited opportunities for further cost-outs, Morgan Stanley reports, given the business today is very lean as it relates to labour, “Further cost cutting would put the business at risk”, management suggested. The group is focused on its “go to market strategy”, range and competitive position, in order to stay in front of customers.

Competitive intensity remains accompanied with deeper and longer promotions. Tradie confidence remains low, management noted. Yet suppliers confirm Total Tools is not losing share. Management is committed to rolling out stores, still confident in its 170 store network target.

Morgan Stanley sees improving sentiment in Metcash’s Hardware division, evident in FY25 results, but says visibility on overall recovery timing and magnitude remains limited.

Building approvals and easing financial conditions are positive signs, though actual building activity and sales remain subdued. FY25 is expected to mark trough margins for Hardware earnings.

Food & Liquor

Metcash controls a network of over 1,600 independently owned supermarkets Australia-wide, including the IGA and Foodland brands. It further controls a chain of convenience stores, which in 2017 was merged with its Campbells Cash & Carry wholesale business.

In Food, on an ex-tobacco basis, Supermarkets revenue was up 3% year on year and Campbells & Convenience was up 6%. Although Tobacco was a headwind, earnings in the segment were solid, Macquarie suggests, with Supermarkets and Campbells & Convenience earnings increasing 5%.

Noting downside risk from tobacco (illegal sales now comprising  around 40% of the market), positively, notes Macquarie, Metcash has been able to offset lower tobacco sales with higher margins, while focusing on the remainder of its Food offering.

In Liquor, Metcash’s independents have continued to see volume growth and market share gains, which is positive, Macquarie suggests, given challenges in the alcohol category (cost of living), albeit earnings remained under pressure (down -2% year on year) with a lower contribution from “strategic buying”.

Food sales were up 11.1% due to the recent Superior Foods acquisition. UBS notes share gains were maintained in Supermarkets, and Convenience saw share gains and contract wins. Earnings grew ex of Superior Foods.

Liquor sales rose 3.4% due to market share gains and new contracts, with earnings down -1.8% due to lower inflation. Tobacco is facing accelerating declines, UBS notes, down -20% in FY25, -29% in the first seven weeks of FY26, and -40% since the peak in FY21.

Excluding tobacco, underlying Food & Liquor sales are resilient, with growth from annualising recent contract wins plus upside from more contract wins. Earnings margins should expand from mix-shift (tobacco low margin) and ongoing cost management.

Once again, Citi is more sanguine.

The supermarkets business has likely benefitted from rising negative sentiment toward the major supermarkets over the last 18 months, Citi suggests. This broker sees this benefit fading with time, also given Woolworths Group’s ((WOW)) efforts to turn around its weak customer perception.

Furthermore, while tobacco makes a low profit contribution, Citi also points to accelerating decline, and it still represents 17% of Food segment sales. Moreover, new legislation taking effect from 1 July (maximum pack size capped at 20, ban on certain flavours etc.) is likely to drive sales down further, putting further pressure on retailer profitability.

Liquor continues to show commendable performance relative to peers, as demonstrated by the 270 bps of share gains since FY22. Citi looks for industry demand to have found a base though notes competitor activity appears to be stepping up.

Mixed Views

For Hardware, a clear determinant from here will be expected RBA rate cuts, which should boost housing construction/renovation and consumer sentiment. Brokers and economists appear quite confident in more rate cuts ahead for 2025.

With inflation easing, the RBA’s decision to cut will more likely be based on a slowing economy, itself driven by a slowing Chinese economy due to Trump’s tariffs. But as the Fed can only continue to suggest with regard its own rate policy, it all depends on where tariffs ultimately land.

Whether a slowing Australian economy will boost consumer confidence, rate cuts notwithstanding, is up for debate. If Trump’s tariffs lead to rising US inflation, and a potential Fed rate hike, the RBA’s policy decisions will become more difficult.

That said…

Metcash offers an appealing investment option, Ord Minnett believes. It is holding its share in the Food business, its Hardware division is set to benefit from an improvement in consumer sentiment, the balance sheet is robust, and management is very capable. Ord Minnett re-iterates a Buy recommendation and raises its target to $4.60 from $4.10.

Macquarie retains Outperform, suggesting its thesis remains intact, with Food & Liquor segments providing a ballast and ongoing recovery in Hardware to drive the share price as momentum accelerates in key housing indicators. Macquarie’s target rises by 8% to $4.00.

UBS retains Buy despite recent share price performance (up 24% year to date, all of which achieved since the Liberation Day dive) as the risk/reward remains attractive due to resilient core Food & Liquor, with contract wins a growth option, and Hardware poised for a recovery, with early signs in IHG from the fourth quarter.

UBS also highlights dividend yield support while de-gearing progresses, with capital management possible in time. UBS’ target rises to $4.25 from $4.00.

Unsurprisingly, Citi has downgraded to Neutral from Buy. Citi cites the aforementioned share price run as contributing, alongside its belief consensus hardware confidence is overblown. Citi’s target nonetheless rises to $3.90 from $3.70.

Morgan Stanley maintains an Equal-weight rating, citing the need for clearer signs of margin rebuild and benefits from the integration of the company’s two Hardware businesses, IHG and Total Tools, while increasing its target to $3.75 from $3.35.

That leaves three Buy or equivalent and two Hold ratings among brokers monitored daily by FNArena covering Metcash. The consensus target is $4.10.

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