When it comes to non-discretionary retailers, Australians are spoilt. We have the extensive store networks of Woolworths Limited (ASX: WOW) and Coles, owned by Wesfarmers Ltd (ASX: WES). Now we also have the cut-price offering from Aldi and Costco, and of course the network of 2,500 independent retailers under the IGA brand, supplied by Metcash Limited (ASX: MTS).
Being Left Behind
Here lies the problem! IGA stores now appear to be in the fifth place in the market, with a market share below 9%. While the stores are generally well located, offer convenient opening hours and often a unique combination of products, the stores are being priced out of the market by the superior buying power of Coles and Woolworths and the all-out discount offering from Aldi and Costo. To make matters worse Metcash's CEO of supermarkets resigned in April.
Poor Performance
I wrote some time ago on the threat that Aldi and Costco posed to Coles and Woolworths, however the impact on Metcash has proven to be far more significant. When Metcash reports its full-year earnings result on June 15, analysts are expecting net profit after tax to fall between 25% and 35% from a year earlier. Dividend per share is predicted to plunge from 18.5 cents to just 13 cents this financial year, implying a massive 9% dividend yield, yet earnings could easily fall another 10% the following year.
Analysts note that Aldi and Costco are highly efficient and offer compelling value, making it very hard for the major chains to compete – particularly the independent supermarkets supplied by Metcash. My colleague Mike King recently produced an in-depth report on the issues Woolworths is seeing as a result of the competitive landscape.
Major Revamp
Metcash has made some tough decisions to get the company back on track. Management announced plans to spend $625 million over five years on creating a world-class supply chain, refurbishing and consolidating existing supermarkets, and improving its fresh food offering in order to arrest the trend of falling sales and margins.
It is also investigating an IPO of Metcash's Automotive network that includes "several leading automotive franchise systems, namely Autobarn, Autopro, ABS and Midas."
Will It Be Enough?
I don't think so. Metcash is spending a lot of cash on its attempt to improve its offering to that of its rivals, but as evidenced by the network expansion of all of its competitors its rivals are not standing still. $2 billion is being spent on 180 new Coles and Woolworths stores nation-wide, implying that IGA's convenient offering may become… less convenient, and I have no doubt that Aldi and Costco are still expanding.
A Dividend Star
I also have no doubt that some investors are buying Metcash shares for the yield. The thing that we need to remember however is that only 12 months ago analysts valued the company at over $3 with a dividend payout of over 20 cents expected this financial year. There's every chance that the 13 cents predicted for this year and 12 cents next year could mean it is valued even lower.
