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Metcash ‘on sale’ compared with Woolworths & Wesfarmers

Over the past year wholesaler Metcash’s (ASX: MTS) share price has trailed not just its two major competitors but also the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO).

As the chart below shows, Metcash has underperformed with a 12% increase against the wider market’s 19.5% rise. Over the same period Woolworths (ASX: WOW) and Wesfarmers (ASX: WES) have outperformed with 21% and 25% returns respectively.

MTS

Source: Google Finance

Metcash’s lacklustre share price growth has widened the gap between the earnings multiple which it trades on compared with the multiple of its two major peers. Arguably that gap is too wide, making Metcash potentially undervalued at present.

According to Morningstar, Metcash is forecast to earn 31.9 cents per share (cps) in financial year (FY) 2014 and pay a dividend of 28 cps. Meanwhile Woolworths is forecast to earn 201.7 cps and pay 141 cps in dividends and Wesfarmers is forecast to earn 218.8 cps and pay 200 cps in dividends.

At current prices, this places Metcash on a forward price-to-earnings (PE) ratio of 11.3 and a dividend yield of 7.76%. While is puts Woolworths on a PE of 16.6 times and yield of 4.2% and Wesfarmers on a PE of 18.2 and yield of 5%.

Of course there are a number of factors that determine any firm’s value. These factors include a company’s return on equity, profit margins and an assessment of future potential.

Metcash is not ‘equivalent’ to its supermarket peers Woolworths and Coles, first and foremost because it is a wholesaler not a retailer. Secondly, Metcash has a less obvious growth path compared with Woolworths and Wesfarmers. All of this combines to be reflected in the lower multiple the company trades on.

For Woolworths presently the company’s major growth avenue is home improvement, primarily via the Masters roll-out. This is also Woolworths’ greatest risk. While Wesfarmers still has potential to grow through improvements within its Coles, Target, Kmart and liquor divisions. There are also opportunities (and risks) within Wesfarmers other divisions including insurance and coal.

Foolish takeaway

Because companies have different growth and risk profiles they rightly deserve different valuations. A company with a lower growth or higher risk profile deserves to trade on a lower multiple than a company with high earnings growth potential and lower risk. With that in mind, there is no reason Metcash, Woolworths and Wesfarmers should all trade on the same multiple of earnings, however as currently priced, Metcash could be underrated.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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