Shares in the embattled grocery and hardware distributor Metcash Limited (ASX: MTS) jumped today following the release of its full year results and the stock could outperform rival Woolworths Limited (ASX: WOW) this year.
It is a surprising turn of events given Metcash's relatively weak market power in the grocery sector, but sentiment towards the company is improving with management restarting its dividend payments sooner than expected as it delivered a 7.7% increase in group earnings before interest and tax (EBIT) to $296.7 million on the back of a 5.4% improvement in group sales to $14.1 billion.
The stock is trading 5.9% higher at $2.32 on the news this morning, which effectively erases all its loss this calendar year and leaves it 1.8% in the black. There're reasons to believe the stock could be heading higher still, which means it could soon be pulling ahead of Woolworths as shares in the supermarket giant are up 5.3% since January.
Metcash Powering Ahead
Source: Google Finance
If this comes to pass, Woolworths may have shot itself in the foot – twice! I'll explain later but let's talk about the factors that are likely to drive Metcash's shares higher in the shorter term.
For one, Metcash's full year result for the year ended 30 April 2017 is ahead of consensus and brokers will be upgrading their forecasts for the group. Consensus data on Reuters show that the mean FY17 underlying earnings per share (EPS) estimate for Metcash is 19.43 cents, or 4.5% below what the company delivered.
That's not a big deal as it is a small beat, but I suspect the stock could be only at the start of the earnings upgrade cycle.
Further, the restarting of its dividend payments with Metcash declaring a 4.5 cents a share final dividend, will attract income seeking investors to the stock. Management is committing to paying 60% of underlying net profit to dividends and this means the stock is yielding around 6% in FY18, or approximately 8% if franking is included.
Another factor that could support the stock is a short-squeeze. Metcash is pretty heavily shorted with around 13% of the stock short-sold (based on the latest ASIC data that is always a week behind). The percentage of its stock that was short-sold six months ago was 10%.
Today's pleasing result could prompt short sellers to buy the stock to close out positions. Short selling is a bearish bet on a stock with investors selling stock they borrowed in the hope of buying it back at a lower price later to profit from the difference.
But can Metcash maintain its growth momentum given that the grocery sector is facing ever-rising competitive pressure from the likes of Aldi and Amazon?
While the grocery division accounts for 65% of group revenue, it is really its hardware division that is the growth engine for the group. Hardware is the primary reason for Metcash's profit growth in FY17 with the division reporting a 47.9% jump in EBIT thanks in part to its acquisition of Home Timber and Hardware (HTH) from Woolworths last year.
Metcash will benefit from the full year contribution from the HTH business in FY18 and management said that synergies are expected to be at the upper end of its $15 million to $20 million target range by the end of FY18.
Hardware has been the undoing of the mighty supermarket chain. It tried to take on Wesfarmers Ltd (ASX: WES) by starting its disastrous Masters chain. It finally conceded defeat and sold all its hardware assets, including HTH.
Metcash investors, don't forget to thank Woolworths as you're going past!
