Stopping the rot at Metcash
When grocery wholesaler Metcash reports its results on June 15 all eyes will be on the pace of its turnaround strategy, profit margins, the value of its automotive business and its relationship with the IGA supermarket chain.
Tensions between Metcash and IGA supermarkets have been bubbling away for years. But as price competition intensifies between Coles and Woolworths, speculation has emerged that some IGA stores are exploring an alternative wholesale distribution model to its Metcash-supplied IGA banner deal.
The chatter comes months after Metcash settled a $12 million legal action with a collapsed IGA supermarket retailer which alleged it was misled by Metcash when it bought a number of stores from the wholesaler.
Metcash has been busily trying to improve relations with the network of 1400 IGA supermarkets – and to stem falling market share – by launching a five-year transformation program. The “diamond” transformation program includes refurbishing hundreds of “tired” stores over the next four years, investing in the supply chain and distribution centres, revamping its Black and Gold brand and rolling out a Price Match program which involves supermarkets matching the prices of key value items to Coles and Woolworths. An estimated 1000 retailers are participating in the diamond competitive pricing programs (price match and the promotional rebate range on Black and Gold brands).
The Australian Financial Review spoke to a range of IGA supermarkets. One of the bigger players had seen some positive results, two smaller operators were confident that the strategy would boost sales but a few others were worried about their bottom line.
Whether the strategy is enough to stop the rot – and restore Metcash’s mantle as the third largest supermarket chain – time will tell.
Meanwhile, the stock has kept the hedge fund community busy, with Metcash the second most shorted stock on the ASX. According to the latest ASIC short position reports table, 17 per cent of its shares are shorted. The analyst community isn’t convinced that its turnaround strategy will work. One analyst, Citi, is one of the only analysts with a buy recommendation on the stock.
In his latest report, CLSA analyst David Thomas, says “We believe the transformation programme is too little, too late and that the independent chains will struggle to keep pace with competitors.”
His comments relate to a survey CLSA conducted of 1400 Australians, called The Tribe Has Spoken 3. It makes the crushing conclusion that there have been some modest improvements in customer perceptions relative to 2013 but “this is not translating into any improvement in spending”.
MOVE AWAY FROM WOOLIES
The survey, asks “Mr and Mrs Australia” which supermarket chain they most associated with a list of eight key metrics, including best prices, best loyalty program, best service, nice place to shop, quality of fresh food and most convenient location, which the respondent then assigns to each supermarket.
“The emphatic message is a move away from Woolworths. Worryingly, the company’s best attributes – range, loyalty and freshness – saw the biggest declines in consumer response. Coles and Aldi were the big winners with the former now outscoring Woolworths in six out of eight critical attributes,” the report says.
It found the responses to IGA were mixed, but an overall improvement on the results of the 2013 survey. However, on key metrics such as the perception of best prices, Metcash went backwards. In terms of measuring the gap on perceptions of best prices relative to Aldi, Metcash scored the worst of all supermarkets. Another metric, being a nice place to shop, Metcash went backwards from 2013, demonstrating deteriorating momentum relative to some of its key rivals.
However, in terms of range and quality of fresh food, there was an improvement. And the success of IGA’s “that’s how the locals like it” advertising campaign improved its score on best location. The 3.5 per cent increase to 17.9 per cent was the strongest attribute result for IGA which has come mostly at the expense of Woolworths.
Metcash is one of the worst performing retail stocks on the ASX. In the past year its shares have plunged a massive 51 per cent, underperforming the overall stock market by a staggering 56 per cent.
Globally, Metcash is trading at the bottom of the valuation spectrum relative to its international peers. It is trading on a prospective price to earnings ratio of 8, compared with the global average for retail stocks of 22 times earnings.
To help strengthen the company’s balance sheet Metcash boss Ian Morrice has appointed Citi to investigate a spin-off and float of its automotive business on the ASX following the successful listing of car parts supplier Burson Group last year.
Morrice will update the market on June 15. This is expected to include better visibility on the valuation of the business and whether Metcash will retain a controlling stake.
The fact that it is considering diluting a highly valuable business speaks volumes about Metcash’s situation. The automotive industry is a high-growth market with high barriers to entry, an established dealer network, higher profit margins than its other concerns and it isn’t exposed to the supermarket juggernauts Coles or Woolworths.
MORE SPENDING NEEDED
However, the business needs more money invested in it and Metcash has a full plate fixing the food and grocery business.
It has prompted speculation that it might consider other asset sales, including hardware and liquor, but this is unlikely.
Metcash is the country’s biggest wholesale supplier to independent retailers. Its main business, IGA Distribution, makes up more than 70 per cent of earnings. The Metcash empire includes liquor, hardware and automotive.
Since Morrice took the top job two years ago the retail sector has become more competitive and the Metcash model has been thrown into question. He is making the right noises in terms of changing the model from a supplier-driven model to a consumer focussed model, but it is costly and it will take time.
He also needs to do more, including addressing the lack of a proper loyalty card. It is understood that the company is looking into various loyalty card options but nothing has been decided.
When Morrice fronts the market on June 15, it will mark almost one year of his turnaround strategy. The market will want to see some green shoots.
It will also want some comfort that the fall in profit margins has come to an end. David Errington at Bank of America Merrill Lynch says in a recent report “EBIT to sales margins in food and grocery are currently falling sharply…which is our major concern toward Metcash.”
In 2013 margins were over 4 per cent and in the second half of 2015, he forecasts margins to fall to just over 2 per cent. Errington says the speed of the fall in margins surprised him. “Our concern is that there is little evidence that it has found a base,” he says in a report.
The market will also be looking for an update on a new head of supermarkets after Fergus Collins left the company in March. Morrice has stepped into fill the breach but given the changes taking place in the division, finding a suitable replacement as soon as possible is crucial.
The country’s $87 billion supermarket sector is going through unprecedented changes with the resurgence of Coles and the entry of discount competitors including Aldi.
It has left Metcash vulnerable.
As Aldi expands into South Australia and Western Australia next year, things will only get tougher. And as Woolworths and Coles slug it out for market share through a price war, the fear is that IGA stores will get caught in the crossfire. Where it may end is why the hedge funds have been heavily shorting Metcash.
Extracted in full from Australian Financial Review.