The surprising share market winner from the grocery war ceasefire

There is little doubt that Woolworths Group Ltd (ASX: WOW) has claimed the upper hand against Wesfarmers Ltd (ASX: WES) during this reporting season as the supermarket wars enter a new phase.

But the biggest winner may not actually be Woolies or Wesfarmers’ owned Coles supermarkets but their small rival Metcash Limited (ASX: MTS).

Metcash had taken the brunt of the battle as it was caught in the crossfire between Woolies, Coles and Aldi with the industry heavyweights slugging it out for market share by slashing prices.

As the African proverb goes – when elephants fight, is it the grass that suffers.

But Metcash has managed to reinvent itself by diversifying more aggressively into hardware and that strategy has paid off with the stock surging nearly 54% over the past 12 months when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) is up around 6%.

In contrast, Woolworths is 8.3% higher, while Wesfarmers is down close to 4%.

Metcash may find a second wind now that Woolies, Coles and Aldi have unofficially declared an uneasy truce by not trying to outdo each other on prices.

The results from Woolies shows it is winning market share against Coles, while Wesfarmers indicated that it has managed to stem the decline in Coles.

Aldi’s land grab in South Australia and Western Australia also looks to be abating and that will give both Woolies and Coles less incentive to slash prices to protect their turf.

The supermarket war may still be raging, but at least the price battles are over (for now). In fact, industry margins may actually be creeping upwards, according to Morgan Stanley.

“Woolworths Food division reported 55bps [basis points] of gross margin expansion with shrinkage/wastage accounting for 30-35bps implying 20-25bps of underlying GM [gross margin] expansion,” said the broker.

“We estimate the sales mix benefit at 10-15bps which suggests that Woolworths sell prices rose by more than buy prices in the 1H.”

Furthermore, Morgan Stanley noted that Coles had guided to a $145 million reduction in 1H18 profitability on a year-on-year basis with $130 million attributed to price and labour, with $15 million from its credit card divestment.

However, profits for the business only declined by $87 million.

Improving margins and stable to higher grocery prices will give underdog Metcash a chance to fire up its food division after a long siege that has forced the group’s IGA chain to promise to price match the majors.

Analysts had been ascribing no real value to Metcash’s food business but if this division can come back to life, it will give the market a new reason to upgrade earnings expectations on Metcash.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Wesfarmers Limited. 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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