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Metcash share price on watch as it may lose another big contract

The Metcash Limited (ASX: MTS) share price could come under pressure on news that it is trying to salvage a large contract with 7-Eleven.

The long-term supply contract is believed to be worth more than $350 million a year, which is significantly more than the $270 million contract to Drakes Supermarkets that Metcash lost recently, according to the Australian Financial Review.

Metcash is already the ugly duckling of the sector. The MTS share price only managed a less than 6% gain when the Coles Group Ltd (ASX: COL) share price rallied 18% and the Woolworths Group Ltd (ASX: WOW) share price jumped 27% since late November last year when Wesfarmers Ltd (ASX: WES) divested Coles.

The independent grocery supplier isn’t keeping up with the broader market either. The S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index added 15% in value over the same period.

Has Metcash already lost part of the 7-Eleven contract?

The news won’t help sentiment. 7-Eleven is calling for new tenders to supply its 700 national stores that turnover $3.4 billion a year as it looks to revamp its supply chain to support growth and a focus on fresh food.

It seems like Metcash may have already lost part of the contract that will expire in August 2020 with the AFR reporting that 7-Eleven is going directly to suppliers for most products for its eastern seaboard stores.

7-Eleven is seeking tenders from suppliers for the rest of the goods for its east coast chain. Metcash is putting in a tender and is negotiating with the 24-hour convenience chain to supply its stores in Western Australia.

Impact on Metcash’s earnings

The silver lining is that the net impact on its bottom line may be less severe than what the contract value implies. Citigroup analyst Bryan Raymond pointed out that Metcash makes thin margins servicing 7-Eleven compared to Drakes.

This means the loss of the 7-Eleven contract could shave $14 million from Metcash’s earnings while the Drake contract would cut $16 million.

That won’t provide much comfort to shareholders though – especially when conditions in the sector appear to be improving.

Food inflation is returning (making it easier for supermarkets to deliver sales growth) and investors have taken a shine to the industry for its defensive earnings at a time when macroeconomic conditions are looking increasingly unstable.

Unfortunately, Metcash won’t be put in the same exalted category when it struggles to keep customers.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. Connect with him on Twitter @brenlau.

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.