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Why Credit Suisse is still not keen on Metcash Limited (ASX:MTS) shares

The big surge in the share price of Metcash Limited (ASX: MTS) on the back of yesterday’s pleasing update hasn’t convinced sceptical brokers that the embattled grocery distributor has turned a corner.

That could explain (in part at least) why Metcash’s share price gave back some of Wednesday’s 10% plus gains as it trades 1.9% in the red at $2.90 in the last half an hour of trade today.

In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is trading just above breakeven as shares in rivals Woolworths Group Ltd (ASX: WOW) and Wesfarmers Ltd (ASX: WES) are down 0.9% and 0.2%, respectively.

Metcash’s big relief rally came on the back of news that the decline in its grocery distribution business is easing even as Wesfarmers-owned Coles supermarkets are winning market share.

Investors were afraid that Metcash would miss consensus expectations.

Those fears have taken a backseat, but this isn’t enough to convince Credit Suisse that the stock looks like a bargain.

“The commitment of larger Foodland retailers in South Australia to a long-term supply agreement is not surprising and serves to reinforce our point that Metcash is likely to achieve better returns by reducing retail activities and focusing on wholesale,” said the broker.

“Metcash has set its sights on building its fresh wholesaling position. In our view, a step change in scale is likely needed and overcoming traditional wholesaler-farm relationships seems challenging. We suspect that acquisition might be needed to achieve a meaningful impact, which would run counter to the cash generation attractiveness of Metcash.”

Credit Suisse has reiterated its “underperform” recommendation on the stock and it isn’t alone. Deutsche Bank has also kept its “sell” call on Metcash even though it acknowledges that there were more positives than negatives from yesterday’s update at Metcash’s annual general meeting.

While there might be light at the end of the tunnel, Metcash is still facing some big challenges.

German budget supermarket Aldi is still expanding in South Australia where Metcash’s independent grocer network is dominant, while the risk of a second supermarket price war is increasing with the impending arrival of another German powerhouse Kaufland.

What’s more, Woolies and Coles are looking to beef up their convenience grocery offering, while Caltex Australia Limited (ASX: CTX) announced on Tuesday that it is focusing on getting more out of its retail outlets at its petrol stations.

But Metcash isn’t without its supporters as the stock is looking cheap relative to its historical valuation. The key difference in opinion between the bulls and bears centres on food price deflation and competition intensity.

The price of a basket of groceries has been falling for several months but some like UBS think deflation is easing and that food prices may start stabilising or rising in the near-term.

The jury is still out on that, as is whether the industry is heading for another bruising price war with the arrival of new competitors, including the prospect of Amazon.com selling groceries.

It’s a bit of rolling the dice here and those looking for stocks with a more certain outlook might prefer to look at what the experts at the Motley Fool are tipping as FY19 winners.

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Motley Fool contributor Brendon Lau owns shares of Caltex Australia Ltd. 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 Scott Phillips.

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