Better Start For Metcash

Array
(
    [0] => Array
        (
            [0] => ((MTS))
            [1] => ((WOW))
            [2] => ((COL))
            [3] => ((EDV))
        )

    [1] => Array
        (
            [0] => MTS
            [1] => WOW
            [2] => COL
            [3] => EDV
        )

)

This story features METCASH LIMITED, and other companies.
For more info SHARE ANALYSIS: MTS
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

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.

Green Shoots?

In the first four weeks of the second half, Metcash reported group sales growth of 2.9%, a run-rate ahead of Ord Minnett’s second half forecast of 1.4%, but the composition was patchy.

Food sales excluding tobacco rose 4.3%, versus a forecast for 3.8%, but liquor, up 0.1% versus an estimate of 2.5%, and hardware, up 3.8% versus an expectation of 8.1%, missed estimates by a long way.

Looking forward, Jarden suggests there is a case for optimism with some early green-shoots in Food (ex-tobacco) and Hardware, with Total Tools like-for-like sales up 9.8% in the first four weeks. However, liquor (flat) was softer, Jarden notes, and remains at risk into the second half.

The recovery in Hardware has commenced, UBS declares, but is varied by states (stronger in Queensland, WA & SA, with Victoria and NSW remaining challenged). Independent Hardware Group’s (IHG) retail network reported positive like-for-like sales growth (up 2.8% versus -6.4% a year ago), while Total Tools delivered stronger growth assisted by new stores.

Earnings margins nevertheless fell due to one-off costs and higher D&A. Looking forward, UBS remains confident in the IHG recovery, yet the path has been elongated. Total Tools growth has improved yet it is more later-cycle and competition pressures remain elevated.

Macquarie remains cautious on the potential for margin recovery with management calling out competition in Food and Hardware, in addition to evidence of heightened competition in Liquor.

One key positive was cash conversion, Macquarie notes, with the three-year cash realisation ratio at 106%, well ahead of the 80-90% guidance range, although management expects this to revert to the upper end of the range.

Citi continues to raise concerns with the extent of earnings growth expectations built into FY27 consensus.

The starting point is lower with material downgrades in Liquor and Hardware. While -$12m of one-off strategy and implementation costs will reverse next year, the Hardware recovery looks likely to disappoint, Citi believes, with detached housing approvals now tracking flat and the interest rate outlook appearing neutral at best.

Morgan Stanley reiterates one-off strategy and integration costs in FY26 will not be repeated in FY27, providing an earnings tailwind.

Some Caution

Five brokers monitored daily by FNArena cover Metcash. Post-result, earnings forecast downgrades have pulled the consensus target down to $3.80 from $4.15.

In deciding upon ratings, brokers have taken into account the stock’s subsequent de-rating.

UBS retains Buy, believing the risk/reward balance remains attractive given resilience and greater diversity in Food, with customer growth a positive for Liquor, Hardware poised for a recovery, with early signs continuing in IHG, and dividend yield support. 

Consensus forecasts are for a 5.5% yield in FY26.

Ord Minnett retains Buy on valuation grounds.

With competitive pressures weighing across business and a more subdued outlook for new housing creation, Macquarie sees the risks as evenly balanced at current pricing, and sticks with Neutral.

Despite the stock having significantly de-rated, Citi looks for FY27 consensus profit forecasts to come down significantly before becoming more constructive, hence a Neutral rating.

Morgan Stanley retains Equal-weight.

If Citi is the least confident, Jarden (not monitored daily) is the most upbeat. Jarden has upgraded Metcash to Overweight from Neutral following recent underperformance, with the view the business is seeing green shoots, is highly cash-generative and is positively leveraged to the cycle with a compelling valuation.

From here, the focus should be on operating leverage, specifically revenue and margin upside via an uptick in the housing, which Jarden sees as significant, with evidence of margin expansion in the second quarter for hardware (ex-integration costs).

Jarden’s updated target is $3.80, from $4.00.

Find out why FNArena subscribers like the service so much: “Your Feedback (Thank You)” – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms