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Metcash shares in strong rebound

Supermarket group Metcash (ASX: MTS) reported half-year results today, with earnings before income tax down 6.3% on the prior corresponding period.

Underlying profit was down 1.9% to $119 million, with the food and grocery division disappointing, while the liquor, hardware and automotive businesses performed reasonably well. The group attributed the drop in earnings to deflationary pressures in Australia, as the price of food and groceries remains locked into Australia’s benign macro environment.

The group is behind supermarket brands and liquor stores such as IGA and the Bottle O. It has been attempting to fight the supermarket duopoly of Woolworths (ASX: WOW) and Wesfarmers (ASX: WES), but the competitive intensity and deflationary environment have proven strong headwinds recently. Price discounting by rivals has forced Metcash to cut its own prices and this has damaged margins and profits even though revenues or sales have grown.

In response, Metcash says it has implemented a strategic review due for completion in February 2014. This includes a food and grocery divisional transformation plan, with six growth drivers to combat competitive pressures and the structural problem of sustained food price deflation. The food and grocery division represents more than three-quarters of group sales, so much will ride on the success of management identifying and executing the right growth strategies.

The group shaved its interim dividend from 11.5 to 9.5 cents per share, a move largely in line with market expectations. Underlying earnings per share (EPS) were 13.5 cents, with the group reconfirming guidance that it expects underlying EPS to be diluted in the high single digits for financial year 2014. The share price has been falling since last autumn, as investors took stock of a tough outlook and expected dividend cut.

Foolish takeaway

As Australia’s third-largest supermarket business, the group has become collateral damage in a price war between Coles and Woolworths. This has eaten into its market share and cut margins. On top of this, Coles and Woolworths have been particularly successful with a relatively new tactic of cross-subsidising fuel and groceries to lock in consumers. To a certain extent the business has been a victim of circumstances beyond its control, but it will need to find earnings growth to reverse its recent decline.

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Motley Fool contributor Tom Richardson owns shares in Metcash. 

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