Why the Metcash Limited share price soared 16% today

Credit: Scott Lewis

Shares of Metcash Limited (ASX: MTS) soared more than 16% today after the company provided an upbeat half-year financial report. Metcash’s share price is now hovering just above $1.54 per share, up from a low of just 96 cents in September.

So What: Metcash is the wholesale distributor for IGA stores around Australia. Unfortunately, what was once a high-quality company has struggled to remain relevant more recently due to competition between Woolworths Limited (ASX: WOW) and Coles, owned by Wesfarmers Ltd (ASX: WES), especially with Aldi now making an aggressive push into the local grocery market.

Here are some of the key highlights from today’s half-year earnings report:

  • Sales revenue up 1.4% to $6.6 billion
  • Reported Profit after Tax up 20% to $122 million
  • Net debt reduced by 34.8% to $435.3 million (gearing reduced to 25.4%)
  • Underlying earnings before interest and tax (EBIT) down 12.7% to $133.7 million
  • ~$100 million in annual savings (more on that below)

We’ll begin by looking at the negatives from the report to get those out of the way.

Firstly, Metcash advised that trading conditions within the market remain highly competitive while it also doesn’t plan to pay a dividend in the 2016 financial year.

Meanwhile, although there was an improvement in both the Liquor and Hardware profits, this was more than offset by the decline in Food & Grocery. Like-for-like sales within the division rose 0.6% but EBIT was down 22.9%.

In order to become more competitive with rivals Woolworths and Wesfarmers, Metcash has had to invest heavily in the group’s turnaround, including reducing in-store prices. This saw Underlying EBIT for the group as a whole fall by 12.7% for the period, but management said “we are seeing evidence the Transformation Plan is producing positive results across the group.”

On another positive note, Metcash has commenced the next stage of the Transformation Plan, known as “Working Smarter”. This is designed to reduce the complexity of the business and Metcash expects it to deliver a gross pre-tax savings run rate of ~$100 million by the 2019 financial year.

The sale of the group’s automotive division to Burson Group Ltd (ASX: BAP) earlier this year also allowed the company to reduce net debt by 34.8%, whilst also strengthening the balance sheet by reducing group gearing.

Although there were plenty of positives to take away from today’s report, Metcash shares still present as a risky investment prospect. While they could continue to climb in price from here, investors should be wary of the intense competition within the sector, as well as Aldi’s and Costco’s ability to continue building their share in the market.

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The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Costco Wholesale. Motley Fool contributor Ryan Newman owns shares of Burson. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. You can follow Ryan on Twitter @ASXvalueinvest.

The Motley Fool Australia owns shares of Burson. 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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