Are Metcash Limited shares cheap? 

Credit: Scott Lewis

Shares in Metcash Limited  (ASX: MTS) have barely budged so far this year and found themselves down just short of 1% from where they closed at in 2015. This is a comparatively good performance for the distributor to brands including IGA, Foodland, Mitre 10, and Cellarbrations, when you compare it to the All Ordinaries which was down 7.3% during the same period.

Despite closing yesterday 11 cents off its 52-week high Metcash is still trading at a price to earnings ratio of just over 8. This is some way off its fierce rivals Woolworths Limited (ASX: WOW) and Wesfarmers Ltd (ASX: WES) which are trading at 12 and 18 times earnings, respectively.

Analysts see little by way of earnings growth for the company in the next couple of years. In fact, they expect earnings to be flat until 2018 when they have forecast a solitary half cent earnings per share increase.

So why are analysts being so negative?

The emergence of Aldi in Australia has shaken the supermarkets and grocery stores industry. According to Roy Morgan Research, after a decade in Australia Aldi has now generated a market share of over 11%, overtaking Metcash which has lost a third of its share during the same period. The Aldi-effect can be seen in the company’s half year results where its Food and Grocery segment produced disappointing year-over-year profit figures that were down by almost 23%.

Metcash has reacted by embarking on a major cost-saving plan that it hopes will save the company $100 million within three years. In an attempt to win on value it has increased the number of price match stores from 600 to 920.

A potential positive is that Metcash’s Mitre 10 brand could benefit from Woolworths’ plan to close its Masters store. It’s still very unclear what will ultimately happen, but the removal of a competitor from the hardware industry could have a positive impact on this segment.

The hardware segment was Metcash’s one shining light in its half-year results producing an increase in year-over-year earnings of 22%. However, as it only contributes 8% of total revenue, it doesn’t have a huge effect on its overall earnings. The biggest segment is its Food & Grocery segment, contributing  69% of total revenue, which is where the major problems lies.

Foolish t akeaway

In light of Aldi’s aggressive expansion plans I would stay away from Metcash right now. While Aldi will attempt to steal market share from Wesfarmers, Woolworths, and Metcash, I feel it is the latter that is most likely to suffer. The shares may be trading at a very low price to earnings ratio and trading in the green today, but that doesn’t necessarily mean they are good value.

BRAND NEW! Our Top Dividend Stock for 2016

Our resident dividend expert names his Top Dividend Share for 2016. Not only are the shares dirt cheap, the company is trading on a 5.6% fully franked dividend yield. Simply click here to gain access to this comprehensive FREE investment report, including the name of this fast growing ASX dividend share. No credit card required!

Motley Fool contributor James Mickleboro has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.