Metcash is a strong competitor in Australian Food, Liquor and Hardware. Its market position has improved, and this provides a moment of opportunity for the company to capitalise.
Time to expand. After ten years of losing market share in Food, MTS stabilised its position at 14% in FY22. It is now reducing its pricing to narrow the discount to the majors and opening new stores. Independents are competitive in Australia and can win on range and service and mostly neutralise on price. At MTS’s metro IGA stores, pricing is now within 2% of the majors on identical branded goods. Five years ago, the discount was 5-10%.
In addition to new stores and refurbishments (Diamond store format) and improving the private label offering, MTS will upgrade its distribution centres in Victoria and WA.
The company’s eCommerce and loyalty programs are embryonic. Other than a partnership with DoorDash and Uber for quick deliveries, each independent retailer is largely in charge of its own destiny in this regard. There are just 220 stores in the fleet of 1,400 using the company’s eCommerce platform and 420 using rapid delivery aggregators.
The Liquor division has enjoyed very strong sales growth in the last two years. It is a clear number two player behind Endeavour Group with 27% market share making it larger than Coles. The division wants to get more retailers onto its IBA banner from the low level of 15% currently. Liquor also has an inadequate eCommerce and loyalty platform and has plans to beef it up. The proportion of owned and exclusive brands will be pushed from 1% currently to 5% of sales over the next two years.
In Hardware, the plan is to attract more ‘whole of house’ spending by lifting the builders’ spend from 36% now to over 50%. Brand positioning and new store openings will also feature for the Mitre 10 brand. MTS is very positive about its Total Tools business where the store count will lift from 100 towards 130 by 2025. The loyalty program here is very strong accounting for 89% of sales across 1.6 million members. MTS aims to have about half of Total Tools stores as corporate or JV stores with the remainder franchised. This acquisition strategy will add most of the divisional $27-32 million capex pa.
Capex climbs. We calculate the aggregate capex over FY23-25f will be $760 million. Acquisitions in Hardware, expanded DCs and other strategic growth plans will materially increase MTS’s capex in the near term. The company has a target range for its leverage of 1.0-1.7x net debt to EBITDA (after depreciation of leases).
Investment View
The trading update for the 23 weeks of the current financial year shows Food sales up 2.6%, Hardware is up 17.1% and Liquor increased 12%.
MTS has navigated the pandemic very well and has emerged with a solid plan to increase its store network both organically and by acquisition (mainly in Hardware). Additional DC capacity together with investment in supply chain and IT is a necessity, but the company is trailing in its eCommerce capability. The extra investment will see capex rise to over $200 million pa over the next three years.
With stronger sales growth, we see fair value for MTS at a PE ratio of 15x. The current PE differential to WOW is ~48%, but we see a ~35% discount as more appropriate.
Risks To Investment View
MTS operates as either the second or third largest player in its markets and is therefore susceptible to decisions made by its competitors. Inflation is beneficial for MTS as long as price competition remains rational. Hardware is cyclical and can be volatile.
Recommendation
We have retained our Buy recommendation.
