Shares in wholesale distribution and marketing company Metcash Limited (ASX: MTS) continued to fall Tuesday following the company's announcement that it lost a major South Australian customer and trading update.
As at mid-afternoon Tuesday, Metcash shares were trading down 1.7%, compared to a 0.9% gain in Wesfarmers Ltd (ASX: WES) and a 0.3% drop in Woolworths Group Ltd (ASX: WOW). Tuesday's fall takes Metcash's losses over the past two trading days to almost 19%.
On Monday, the company announced that its South Australian customer, Drakes Supermarkets, would not use Metcash's distribution centre beyond the end of an agreement between the two companies in June 2019.
Metcash also announced that expects to report a 1.2 per cent sales decline at its supermarkets and convenience business for the full year ending 30 April 2018, and a 3.6 per cent sales decline at its wholesale business, excluding tobacco.
Despite the bad news, there are some compelling reasons why the stock is worth a look right now, namely its low earnings multiple, earnings diversification from its hardware and liquor businesses and the impact of the loss of Drake's being contained.
Ord Minnett agrees, noting that easing food deflation is also a positive, as well as a moderation in growth from competitor Aldi, and the Coles demerger creating an environment whereby food deflation could further reduce.
At the same time, it says the independent retailer environment appears to be in better shape, whilst cost savings present potential upside.
"We see valuation upside potential, noting Metcash's low earnings multiple despite strong growth, as previous multiple ranges do not reflect the changed business mix," it said in a report.
The broker has an "Accumulate" rating on Metcash and a price target of $3.60.
Ord Minnett also adds that it is confident that Metcash will retain its customers in South Australia, despite the Drake's update.
Morgan Stanley also sees the Drake situation as an isolated incident.
"We think the prospect of incremental independent supermarkets establishing their own distribution is low given 1) high fixed costs and 2) low existing profit margins. We wouldn't rule out the possibility of Drakes eventually moving back to MTS distribution in future after negotiating terms," the broker said in a report.
Morgan Stanley also believes the share price slump is overdone, given the earnings impact and Metcash's increasing earnings diversification through recent acquisitions in the hardware and liquor sectors.
Morgan Stanley has an "Overweight" rating on Metcash. It lowered its FY18/19 earnings estimates by -1% on the back of guidance for flat FY18 earnings in the Food business and lowered its FY20 earnings estimates fall by 5% due to the impact of lost Drake supermarket sales
