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Should you buy Metcash Limited in 2014?

Metcash Limited (ASX: MTS) shares have rebounded mildly from their April 2014 low of $2.54 to trade today at around $2.92. The 15% jump has been great for investors that got in at the right time, but should investors be confident that the share price will continue rising?

Background

Metcash is a wholesaler of groceries to around 2,500 independent grocery stores around Australia. The share price plunged to a near 10-year low in April when the company announced that profit would fall by up to 15% this year, while the dividend payout will fall by over 25% as the payout ratio would be cut from 80% to 60% on lower profits.

Major Rivals

The root of Metcash’s problems is that it cannot sell goods to its network of supermarkets at a price that will allow them to compete with major rivals Woolworths Limited (ASX: WOW) and Coles, owned by Wesfarmers Ltd (ASX: WES).

Metcash plans on spending $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.

Will It Be Enough?

I don’t think so. Metcash is spending a lot of cash on its attempt to improve its offering over that of its rivals, but as evidenced by the Wesfarmers strategy day last week, rivals are not standing still. Coles’ management believe they have a long way to go yet in supply chain efficiency and fresh food sales. The company believes prices will continue to be driven lower by competition from Woolworths, but also from international chains such as Aldi and Costco.

Metcash also have to contend with the increased presence and saturation of rival stores. With $2 billion being spent on 180 new Coles and Woolworths stores nationwide, the ‘convenience’ offered by independent grocers will be eroded further.

Forecasts

Analyst forecasts for the company are fairly unanimous in expecting a fall in profits both in FY14 and FY15. A reduction in payout ratio from 80% to 60% could see the dividend fall to 17 cents per share in FY14 and around 15 cents in FY15. This would represent nearly a 50% fall in dividend over two years.

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Motley Fool contributor Andrew Mudie does not own shares in any companies mentioned. You can find Andrew on Twitter @andrewmudie

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