Mixed Goods

Metcash's FY17 net profit of $194.8 million and earnings before interest and tax of $296.7 million were ahead of both Ord Minnett and median consensus forecasts, led by the liquor and hardware divisions, although the core food division remains challenged. A dividend of 4.5 cents per share was declared for second half of FY17, an earlier return to payouts than previous company guidance for the first half of FY18.

 

We have cut our EPS forecasts by 7.1% and 5.3% for FY18 and FY19, respectively. The key changes in our model update are reduced net interest expense in the near term as net debt is lowered and reduced corporate costs. Meanwhile, net interest expense in the long term is increased slightly as finance costs from the discounting of provisions is assumed to occur for longer, albeit at a declining rate.  We also adjust the first-half and second-half scheduling of the dividend to be more consistent with the historical pattern of just over 40% in the first half of the financial year.

 

Food sales remain challenged due to the weak Western Australia economy and the competitive environment, with the prospect of a return to food inflation uncertain. The cost-saving target has been increased, and while it could increase again, the restructuring costs required appear to have risen. Moreover, the revenue challenges in food are structural while the cost savings pipeline is finite. Hardware remains a big opportunity, although the path of synergies is a little later than expected, and it is too early to tell how Home, Timber & Hardware members will receive new buying terms.

 

Nonetheless, cash generation is strong and the degree of deleveraging at Metcash since 2012 – aided by the sale of the automotive division but also with prudence in cash use – is commendable, and supports a strong dividend yield. This mixed investment thesis underpins our recently upgraded Hold recommendation on Metcash although we note the absence support for our valuation of $2.08 a share is a growing concern.

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