The clock is ticking for Metcash Limited (ASX: MTS).
While it was once a dominant force in Australia's multi-billion dollar grocery industry, Metcash is now fighting to remain relevant with the industry becoming dangerously competitive, with some pundits even suggesting the company could be a prime candidate for private equity.
Metcash is the country's biggest wholesale supplier to independent retailers including, but not limited to, IGA, Foodworks and 7-Eleven petrol stations. While this division generates the largest portion of the group's overall earnings, The Australian Financial Review reported that the market is giving the segment a zero valuation.
To put it another way, the group's liquor and hardware businesses could be worth more than the company's overall market capitalisation of $1 billion with its shares sitting at just $1.08 – down 75% since May 2013. Based on this logic, investors (or private equity) who buy today would receive the wholesale grocery business for free.
Should you buy?
With the Australian dollar languishing around a six-year low level and the market taking a beating in recent weeks, private equity could certainly be running the ruler over the company's books. But buying a company's shares based on the belief that it will be taken over is a dangerous game to play, and one that has burned many investors in the past.
If private equity doesn't make a play for the business, investors need to understand what they're left with.
The fact is, Metcash is struggling to remain relevant in Australia's $90 billion grocery channel, with some analysts even going so far as to say it won't be around in 10 years' time. With Coles – owned by Wesfarmers Ltd (ASX: WES) – and Aldi quickly taking market share, Woolworths Limited (ASX: WOW) is fighting tooth and nail to regain its dominance in the industry which could create a full-blown pricing war.
To combat this, Metcash has committed $600 million in capital to turn its struggling wholesale business around, and even sold its automotive division (at a significant discount) to free up some cash to fund the initiative. From this, there are three distinct possibilities:
- The $600 million will help the company return to a dominant position within the industry
- The $600 million won't be enough to make a significant difference, thus deeming the massive investment a waste
- The turnaround won't work, and the company will be $600 million worse off than it was before.
To be clear, investors should never invest in a company based soley on the idea that it could become a takeover target, or that it could be in the sights of private equity. If a bid is launched for the business, investors holding the shares at the time will be well rewarded. But if private equity chooses to hold off from launching an offer, the shares could continue to fall in price, hurting those holding the shares.
In my opinion, investors should at very least wait until the company has provided an update on its turnaround, and keep an open mind that Metcash could certainly become a casualty in Australia's red-hot supermarket industry.
