It can happen to the seemingly strongest businesses – a small, yet nimble and clever company moves in next-door and starts stealing your customers one-by-one. Your customers leave because; while you thought they appreciated your fancy, slightly more expensive products and convenient shop locations, it turns out they're a sucker for saving money on everyday purchases.
Welcome to the story of grocery supplier Metcash Limited (ASX: MTS). The company, which supplies a network of 2,500 independent retailers under the IGA brand, on Thursday announced a surprise market update that sent the group's share price 18% lower to a 14-year low!
Expectations vs Reality
Metcash announced that it would take a $640 million profit write-down due to "an increasingly competitive trading environment", particularly in food and grocery.
This means Metcash will report a loss in excess of $400 million for the 12 months ending April 2015, compared to a consensus forecast of a profit of over $180 million prior to the announcement.
Just 12 months ago analysts expected a total dividend payout of 17.1 cents this financial year, representing a 15% yield based on today's price of $1.12, and even six months ago they were expecting 12.5 cents. Today we know that Metcash will not pay a final dividend this year or a dividend at all next financial year, a catastrophe for many investors that were sold the company's dividend story.
Competitive Edge
The same story can be seen, albeit to a lesser extent, at Woolworths Limited (ASX: WOW). It's now widely expected that Woolworths will drop gross margins and limit dividend growth to combat the increasingly competitive Aldi and the improving offering from Coles, owned by Wesfarmers Ltd (ASX: WES).
For Metcash, lowering debt will greatly reduce the investment risk and improve the group's flexibility and competitiveness. Metcash's debt load of between $800 and $900 million is getting precariously close to its market cap of $1.3 billion. Dropping dividends will save approximately $200 million over the next two years and the sale of the group's automotive business could raise another $200 to $300 million.
Will it help?
Some analysts have written the company off. As I discussed last week before the announcement, I don't think Metcash is doing enough to even maintain its position in the market. Woolworths generates $44 billion of supermarket sales, Coles $36 billion, while Metcash generates just $13 billion.
IGA stores are now in fourth or fifth place in the market, with a market share below 9% and falling. IGA stores are generally well located, offer convenient opening hours and often a unique combination of products, but 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.
A Dividend Star
Its alarmingly clear now that investors should never invest in diminishing businesses where analysts are predicting a gradual fall in earnings and/or dividends over time. Falling dividends imply that either operational costs are increasing or sales are falling.
