Better Start For Metcash

Australia | 10:00 AM

Following a surprisingly weak first half, Metcash’s early second half metrics suggest improvement, perhaps signalling a trough, although caution remains.

-Metcash posts first half earnings miss
-Food okay, but Liquor and Hardware disappoint
-RBA policy a headwind for Hardware sales
-Competition rife in Liquor

By Greg Peel

The share price of grocery wholesaler and hardware chain Metcash ((MTS)) plunged -9% on the release of the company’s first half FY26 (April year-end) result, which showed earnings -5% short of consensus.

The 'miss' was driven partly by the earlier recognition of restructuring costs than consensus had forecast. The key food business (IGA and other chains) met forecasts, but the hardware (IHG, Total Tools) and liquor (IGA) divisions both fell short of expectations.

Analysts agree the Food business performed relatively well. The commercial food services division increased earnings before interest and tax by 1.4%. In Ord Minnett’s view, this was a creditable performance given sales of tobacco dived -35% on a year ago, the same sort of slide we have seen across the other tobacco retailers Woolworths Group ((WOW)) and Coles Group ((COL)).

Excluding the decline in tobacco sales, revenue increased circa 7%. As Macquarie notes, earnings were offset by improving margins given lower tobacco sales.

While competitive intensity has increased, IGA price competitiveness has improved, Morgan Stanley notes. Improved product mix and improved contribution from food service and convenience drove margin expansion. Management suggested it still has levers in food to defend margins despite the competitive environment.

As had been highlighted by rivals Endeavour Group ((EDV)) and Coles, the liquor market continues to be a struggle, as the industry faces headwinds from changing consumer attitudes to health and cost of living pressures. Liquor earnings fell -8.4% excluding reconstruction costs.

Analysts highlight the risk of greater promotional intensity from rivals as suppliers battle for market share.

Coles has a new strategy to boost its liquor market share, forcing Endeavour to respond. Lower price inflation and flat volumes make absorption of cost of doing business inflation more difficult. Despite these difficult trading conditions, Morgan Stanley notes Metcash is actually gaining share and sees improved strategic positioning.

Though Metcash’s independents continue to take share, this doesn’t appear sustainable to Citi, with the major competitors (particularly Endeavour) looking to arrest share declines.

Metcash has signaled it will not fund increased discounting, but further margin decline appears likely with sales growth unlikely to match cost growth and strategic buying gains being more limited in a less inflationary pricing environment.

Hardware Getting Harder

Hardware earnings for the first half fell -4% -- the fifth-straight half-year fall. In Macquarie’s view, the key source of earnings and valuation upside for Metcash is in Hardware.

Macquarie had previously been positive due to improving housing signals, including increases from the trough in approvals and new home sales. While the trajectory in these indicators remain on an upward trajectory, recent macro updates, including the October CPI, and implications for the cash rate suggest the potential upside is more constrained.

One would expect that perennially rising house prices and the federal and state governments desperate attempts to increase housing supply would be positive drivers for hardware sales.

Prior to Metcash’s result, much of the consensus FY27 profit growth forecast of 14% hinged on a 15% earnings uplift in Hardware. Citi continues to view this as overly optimistic considering detached housing approvals were flat year on year in September and the interest rate outlook is for no more rate cuts, with the possibility of hikes next year.

Hardware suffered retail margin pressure, Morgan Stanley notes, driven by trade distribution sites where competitive pressure remains elevated. Total Tools’ retail margins were nevertheless more consistent.

As volume lifts in hardware, Metcash’s plan is designed to deliver earnings leverage. But the focus remains on execution. Morgans Stanley comments while excess market capacity exists, pricing power is limited.

That said, Metcash highlighted the division lifted earnings in the second quarter, (three months to October), which provides Ord Minnett with some confidence the bottom may have been reached.

This broker notes, however, any uptick in the housing market that would materially lift hardware earnings is unlikely to be as strong as previously anticipated given the broader inflation and interest rate environment.

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