Shareholders in Metcash Limited (ASX: MTS) have had a rough ride over the past year, but if you're new to the story here's a quick recap:
- Competition from Woolworths Limited (ASX: WOW), Wesfarmers Ltd (ASX: WES) and Aldi is stealing customers and squeezing margins
- A half-year report that revealed underlying profit shrank 9% was the catalyst for a massive sell-off that wiped 50% off Metcash's market value
- Metcash has subsequently been investigating selling its automotive division to fund an ongoing transformation of its stores and operating model
With two weeks leading up to the release of the annual report on June 15, shareholders and prospective investors will be watching closely – with an estimated 17% of its shares sold short, a negative report could see a dramatic fall in prices.
On the other hand Metcash is trading at an appealing price, with a forward Price to Earnings (P/E) valuation of between 6 and 8 depending on how impacted its profits might be this year. It also offers a forecast dividend yield of around 8%, fully franked.
Where to from here?
Unfortunately with a cash balance of only $45 million as of 31 October, 2014, Metcash will need more funds in order to fulfil its plans to rejuvenate a number of its stores. This is where the sale of the automotive division comes in. Burson Group Ltd (ASX: BAP) has already expressed an interest, but it may have its hands full with a recent move into Western Australia.
I'm not sure that it's a wise decision at all to sell a business that reported a 21% increase in sales in the first half of this year (partly due to acquisitions). The money from a high-growth business will be channelled into the low-growth grocery business that will even at its best still have to compete on price and offering with Woolworths, Coles, and Aldi – which will constrain growth.
In terms of groceries, management's decision to price match key items at competitors' stores has thus far been successful at stemming sales declines, and the Diamond Store Accelerator program has so far managed to increase customer transactions and basket sizes.
These are both necessary initiatives given that groceries are by far the major earner, but I don't believe it is a sound strategy to remove one of the pillars (Automotive) that differentiates Metcash from Woolworths and Wesfarmers.
Without the automotive business, Metcash is exactly like Woolworths and Wesfarmers (grocery, hardware, and liquor), only smaller and less competitive. There's no reason (apart from the funds shortage) Metcash can't have multiple successful businesses, especially when it's nurtured Automotive well thus far.
However without that business, unless the company can effectively steal market share – and there are some signs that it can do just that – I think the company will get squeezed too much between its competitors to have a happy ending.
Investors should have a look at Metcash after its June 15 report. While its situation and price have definitely caught my attention, I must admit I have zero interest in owning the stock sans automotive division.
