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One big reason to avoid Metcash Limited

The case for buying shares in grocery wholesaler and IGA-banner owner Metcash Limited (ASX: MTS) continues to look weak following news that supermarket groups Woolworths Limited (ASX: WOW) and Coles, which is owned by Wesfarmers Ltd (ASX: WES) are planning to push further into the convenience store sector.

According to a report by Australian Food News, the supermarket giants are focussed on capturing market share from smaller format players such as 7-Eleven and City Convenience stores but no doubt Metcash’s IGA stores will find themselves at the forefront of heightened competition too.

The report suggests that the convenience sector has been growing at approximately 4% per annum recently with expectations that similar levels of growth can be achieved in the future. Given the increased population density and apartment living trend underway in Australia’s capital cities, it’s no wonder that smaller format supermarkets could prove popular.

The decision by Woolworths and Coles to target this area will no doubt prove popular with customers given their brand strength, scale advantages and customer rewards offers. The move of course won’t be popular with the owners of competing formats such as 7-Eleven and IGA.

As I stated here, despite the tanking of Metcash’s share price, Woolworths still looks a better bet…the same could be said for shares in Wesfarmers as well.

Unfortunately for Metcash’s shareholders, the competitive squeeze on the group does not look like it will let-up any time soon – that means its earnings growth will likely remain under pressure with management having to run fast just to stop the company from going backwards.

The likely winners from this heightened competition are shareholders in blue-chips Woolworths and Wesfarmers. Their winning will likely be at Metcash’s expense which is why the stock is probably best avoided for now.

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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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