Metcash chief executive Jeff Adams said it’s too early to say if there will be redundancies at the wholesaler as he sought to downplay the loss of the majority of an $800 million contract with convenience store network 7-Eleven.

7-Eleven, which has 700 stores around Australia and annual sales of more than $3.4 billion, told Metcash that it will not be renewing the current supply agreement following its conclusion in August 2020. The pair were unable to agree over requirements for the east coast, including delivery routes and scheduling.

Shares in the wholesaler dived more than 10 per cent on Friday, but ended the day 6.9 per cent lower at $2.83 each on the news, which was foreshadowed by The Australian Financial Review in early October.

Total annual sales to 7-Eleven are about $800 million and account for about half of Metcash’s total convenience business. The 7-Eleven sales comprise predominantly lower-margin tobacco, soft drinks and snacks.

It is believed that 7-Eleven wanted a four-hour delivery window and seven-day-a-week delivery into stores from Metcash.

The loss is a blow to Metcash, which recently lost a $270 million a year agreement with Drakes Supermarkets, one of its biggest customers.

Mr Adams told AFR Weekend that 7-Eleven’s requirements would lead to supply being uneconomic for its convenience business. It remains in discussions to continue supply in Western Australia, as well as a number of smaller categories on the east coast.

It was only on Friday at noon that Mr Adams got the news 7-Eleven would self-supply, which he calling “disappointing”.

“One thing to keep in mind, this is very different to a full supermarket contract,” he said. “It’s a very low margin. We don’t do anything but move boxes for these guys.”

He added that the talks are “going well” regarding the continued supply of WA and the tail of their range.

Given the contract expires next year, it gives Metcash plenty of time to “to get the costs out.”

“We have not even looked at [redundancies] to be honest,” he said. “We will look over the next months over the cost base.”

Alphinity portfolio manager Bruce Smith is not a Metcash investor but said any time a company gives away a chunk of revenue, there are previously fixed costs that may be no longer covered.

“I understand the business they lost is not particularly profitable, so might not be as big as whole as it seems … but it makes for more of a struggle to get by,” he said.

Growing pressure

Metcash wholesales to a network of over 1600 independently owned stores Australia-wide, including the IGA and Foodland brands. It has been under growing pressure to cut prices to stop independent retailers and convenience chains from directly sourcing from suppliers or moving to self-supply.

Metcash has been supplying 7-Eleven since 2005, when the convenience store chain had about 350 franchised stores.

7-Eleven, which is owned by the Withers and Barlow families, has grown significantly in recent years and now has the scale to negotiate more competitive trading terms with food and grocery suppliers.

According to the most recent accounts filed with ASIC, 7-Eleven’s sales rose 21 per cent to $3.4 billion in the 12 months ending June 2018, boosted by new store openings and strong same-store sales growth in merchandise and fuel.

Simon Mawhinney, managing director of major shareholder Allan Gray, said this situation was reminiscent of the situation Sigma Healthcare faced with its major customer, Chemist Warehouse.

“They can’t enter into contracts that would be loss-making for shareholders – that is not the road to riches,” he said. “No company survives by writing unprofitable business.

“The biggest concern here is if Metcash customers could bypass and receive better service and at a lower cost, then that is a problem for Metcash, but it sounds like that is not the case.”

Evans & Partners analysts expect Metcash will lose about $600 million of sales and retain around 25 per cent of the contract in Western Australia and slow-moving products. The firm is forecasting a $10 million impact on operating profits before interest and tax.

All up, given the lost sales relate to low-margin products, they see a 3 per cent impact on earnings per share.

In terms of the risk of other contract losses, they noted that there are only a few IGA retailers of sufficient size to start their own wholesaling operations; Ritchies is the largest Metcash grocery customer, but is partially owned by Metcash; Foodworks has a fragmented ownership structure, posing less of a threat – unlike Drakes, which is owned by a single person.

Metcash will report 2020 first-half results on December 5.

Extracted from AFR