Better food market share and a skew to trade in hardware sets Metcash apart from its larger supermarket rivals. MTS’s Food business has fundamentally improved since 2018. The Food business accounts for 40% of earnings and certainly benefitted from higher sales due to COVID lockdowns. But MTS has improved three aspects in particular, that have made it a better business:
- An improved price position relative to Woolworths and Coles.
- Independent supermarket store count has been largely stable for 3 years while Coles, Woolworths and Aldi have slowed their rate of space growth.
- Profitability for IGA retailers has improved.
Consequently, MTS has enjoyed a stable share of the food market.
The business is facing flat margins over the next few years as cost growth infects wages, electricity and transport. Employee costs are about two-thirds of total operating costs.
The Hardware business has a skew towards trade sales. It is less likely to experience slowing sales as retail is a smaller part of the equation – trade sales represent about 65% of segment sales. Trade activity will be supported by a long tail of construction activity that may last for 12-18 months. Within the hardware segment, MTS has wholesale sales, the Independent Hardware Group and Total Tools. The latter has much higher margins and its sales are supported by the shift towards corporate stores.
New CEO Doug Jones may want to lift capex. MTS had already set out its long term strategy in March 2021, but Mr Jones may want to adjust it according to his thinking. MTS has planned for additional store refurbishments, a stronger eCommerce and loyalty program and improved supply chain logistics. The capex program for stage 1 of the Project Horizon project which currently sits at $70-80 million over FY21-23f.
The second stage is not yet quantified but will build on systems and insights capabilities for the company and its retailers. There may be opportunities to improve engagement with suppliers, build on a solid liquor retailing position (larger than Coles), look at private label products and, like everyone else, increase online sales.
Investment view
MTS has repositioned itself with a stabilised grocery wholesaling business, growth opportunities in hardware retailing and an improved balance sheet.
The company is trading on a PE of 14x FY22 eps which is well below its peers and offers an attractive dividend yield. The recent share price pullback presents an opportunity to buy a stock that will benefit from higher inflation and has a better position in hardware due to its greater exposure to trade sales.
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.
