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Metcash Limited lifts on result: Is it a buy?

Investors aren’t quite sure what to make of Metcash Limited’s (ASX: MTS) full year result as the grocery distributor announced the successful sale of its automotive division and reported a net profit that is slightly ahead of market expectations.

The stock dipped 0.9% in the red at the open before staging a comeback to trade 3.2% higher at $1.14 after management turned in a 1.7% increase in group sales to $13.63 billion and a 19.6% drop in underlying earnings per share (EPS) to 21.3 cents for the year ended April, 2015.

Analysts polled on Reuters were expecting sales of $13.53 billion and EPS of 20.9 cents.

Metcash will also get around a $210 million after tax boost to its bottom line after it sold its Autobarn business to Burson Group Ltd (ASX: BAP).

However, the real surprise was in the earnings before interest and tax (EBIT) margin for its key grocery division.

While this compressed to 2.4% from last year’s 3.2% due to intense competition, many were bracing for a sharper dive to around 1.1%.

I think margin could fall further but it is unlikely to fall under 2% unless something unexpected happens.

If anything, management says its transformation strategy is already paying off. Metcash has launched a pricing guarantee to match the prices of its groceries against its larger rivals, increased its generic brand and fresh food offering, and is undertaking store refurbishments.

The group said that it enjoyed a 16% increase in wholesale sales to the 52 stores that were refurbished and another 100 stores are being targeted in the current financial year. Metcash has over 1,300 stores in its IGA branded network.

The rest of the stores may have also turned a corner as like-for-like sales increased 0.7% in 2014-15 compared with a 1.1% decline in the year before.

Its hardware business also reported a pleasing set of numbers with sales growth of 11.3% to reach over $1 billion for the first time.

The results may be enough to convince the market that Metcash’s operations are starting to stabilise but shareholders are unlikely to see much financial improvement in its troubled grocery division for at least 12 months.

What I think is a key worry for Metcash shareholders is the aggressive $650 million expansion strategy that’s being undertaken by Woolworths Limited (ASX: WOW). You can bet there will also be a competitive response from Wesfarmers Ltd (ASX: WES), the owner of Coles supermarkets, as well.

But given that the stock is wallowing at 14-year lows, I am not surprised to see it bounce. There may even be more upside for the stock although I think a lot more water has to pass under Metcash’s bridge before anyone can say definitively that it’s on the path to recovery.

From that perspective, I would sleep better if I invested in Woolworths or Wesfarmers instead. Metcash is cheap but it’s only for the brave.

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Motley Fool contributor Brendon Lau has no position in any stocks mentioned. Follow me on Twitter - https://twitter.com/brenlau

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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