Metcash: add to cart?

READ

Most investors think of Metcash as a food wholesaler to the IGA supermarket chain, but it’s a lot more than that.  Metcash has ‘three pillars’ to its business – food, liquor and hardware – and while the food business is the big name, IML portfolio managers Hugh Giddy and Tim Wood explain that the liquor and hardware divisions hold much of the value and are likely to drive much of the future growth.

Edited transcript

Hugh: Welcome everybody. This month we’re talking about Metcash. Metcash is a stock I’ve followed for a long time. And, we’re finding that we’ve got increasing interest in it at the moment, the valuation is appealing. Metcash has traditionally been the wholesaler to the independent supermarkets. The IGAs of Australia in different formats, and the independent liquor stores but, over time, they’ve also gotten hardware and, hardware is what’s really exciting us now. Isn’t it?

Tim: Yeah. I agree. So hardware’s been the growth driver for Metcash over the last few years. If we have a look at the business, I think people traditionally think of it as a food and liquor wholesaler. And while that’s still true, they still do those activities. FY23 was the first year where hardware profits were actually bigger than food profits. And so even though food is a significant revenue generator for the company, we’ve got to remember that Metcash are really only a wholesaler to the food and the liquor businesses where they earn about a 2% margin. Whereas within hardware, in addition to being the wholesaler, they also earn retail profits because they own the majority of some of the stores within both Mitre 10 and Total Tools. So their margins there are significantly higher. So the hardware business, they bought Total Tools just at the start of COVID. Absolutely stole it in my opinion turns out to be a great acquisition.

Hugh: Done really well.

Tim: Done really well. Private equity was supposed to buy it. Got cold feet because of COVID and Metcash were in there to mop it up at a really, really attractive price. So within the hardware business, they, supply to the Mitre 10 network, the Home Hardware network, and they’re wanting to consolidate all of those independent hardware brands into those two main brands plus the newly acquired Total Tools business where they started out being just the franchisor, which is, of course, very high margin. And more and more, they’re buying into some of the underlying stores, and they want about 50% of that network to be company owned, over time.

The second great business I think within Metcash is the liquor business. I think it’s a little bit underappreciated. It is the smallest part of our valuation, the smallest part of profit. But it’s around 20-25%, of our valuation. And has grown really consistently over time. We were reflecting earlier today that over the last ten years, compound EBIT growth has been around 8.5%. Obviously, boosted by COVID the last few years, but even prior to COVID, the FY13 to FY19 period, still grew 7.5%, which is incredibly, incredibly strong. And a business that should probably trade on a higher multiple than the food business for that growth outlook. They are the second largest liquor business in Australia, obviously smaller than Endeavor Group with Dan’s [Murphy’s] and BWS, but at a wholesale level, they supply more liquor than the Coles business.

Hugh: Sure. Now, and the food business isn’t a disaster. They have had a lot of challenges with the entry of Aldi, Costco. Woolworths and Coles are very dominant, have a lot of buying power. But I think that, COVID showed that the IGA stores are competitive. They range better, they have done a price match. So they did gain some share COVID. I don’t think they’re going to give all of that back. And the retailers, the independent retailers, the IGA owners, did make a lot of money in COVID, and they’ve been reinvesting in their stores and refurbishing their stores. So it may not be a fast grower, but, a lot of people, I think, associate Metcash mostly with food, And food’s not, as I say, no disaster, but the other divisions, certainly, the other pillars, as they call them, are quite attractive. How are we thinking about valuation and the balance sheet and so forth?

Tim: Yeah. Sure. So obviously, the big three divisions, food, hardware, and liquor, we do think that in food, they are up against some very strong competitors in Woolworths and Coles, Aldi as well. So it is a lot lower multiple business to us. Probably should be about the same multiple that the whole company trades on about 12.5 times. But given the growth tailwinds that are behind both liquor and hardware, we think they’re higher multiple businesses. So we ascribe a higher multiple to those companies. If we have a look at the the earning split of the company, as we said, hardware is now the largest division within the company. But if we have a look at a valuation split, hardware is nearly 50% of our valuation.

And when we include liquor with that hardware business, it’s about two thirds of our valuation. So, the food business is only about a third of the valuation, at the stage. It’s trading on about a 5.7% dividend yield that we think grows over time, and that’s at only about a 70% payout ratio. So, room to be able to reinvest within the business to keep that growth track going. Balance sheets come from being very strong. They did a buyback in FY22. It’s still a good balance sheet. Should still enable them to be able to invest in these growth initiatives particularly across the hardware business. So, valuation looks attractive to us, and, it’s a conviction holding across many of the IML portfolios.

Hugh: Sure. Looks good in this market.