Short sellers cash in on Metcash misery

Elizabeth Knight
June 5, 2015
The Age
It’s not the $640 million writedown in Metcash’s grocery business that was responsible for the 17 per cent fall in its share price. Rather, it was abandonment of its dividend for the next 18 months. The last vestige of support for the share price had until Wednesday been on the back of its 8.4 per cent dividend yield.
Given its prospective dividend yield is now zero, it will be tough to find share price support for a company whose major business is losing market share, whose earnings and balance sheet are under pressure and whose wholesale customers are reported to be sufficiently restless they are casting around to replace Metcash as their supplier.
The announcement from Metcash on Thursday underscores the perils of investing in some high yielding stocks, which have a shaky earnings outlook.
Even the far more reliable banking shares that have been yield favourites have been sold off in recent weeks as the rate of their earnings growth has come under pressure.
For high-yield junkies, Metcash has long been a punt, and a pretty dangerous one with long odds. It was also a punt for the investors who have been heavily shorting the scrip in expectation it would fall. For the latter, it was a gamble that paid off in spades.
That Metcash was in need of a balance sheet tidy was a given because the earnings from the grocery division could no longer support the asset valuations.
Last December, it shocked the market with a mammoth downgrade to this year’s earnings forecasts – some $30 million shy of analysts’ then-expectations.
In addition, the Australian Securities and Investments Commission has put pressure on companies for a year to reduce asset valuations to a level that properly reflects the earnings they generate – a point the regulator reiterated this week.
In Metcash’s case, taking the knife to asset valuations recognises the fact that a growth in its food and grocery division’s performance will be difficult to achieve and, to the extent that its restructuring is successful, it could also be a long way off.
Thus, while it is unpopular with investors, erasing dividends for a while is probably a prudent response for the company that has more than its fair share of challenges.
Metcash chief executive Ian Morrice needs all the capital expenditure he can muster to plough into what it bills as its transformational “diamond-store advantage” project that involves store refurbishment and investment in prices.
The company’s mooted sale of its car accessories retailer, Autobarn, will give it an injection of cash but only enough to ease some of its debt pressure – and some would say only enough to ensure solvency. Investors will get an update on this divestment process on June 15 when the group’s full-year earnings are released.
His announcement in June will also contain an update on how the transformation project – that many say is not yet delivering meaningful results – is progressing.
But the market will be disappointed if Metcash sells the auto division for anything less than top dollar. And there is yawning gap in the range of the anticipated price tag – around $215 million to $460 million.
“We think selling what is a growth business with upside via supply chain integration with Mitre 10 highlights the pressure Metcash is under to reduce gearing,” UBS recently said in a note to investors.
“A divestment (IPO) of Auto would alleviate near-term balance sheet concerns.”
Meanwhile, it would too simplistic to blame Metcash’s woes on the ascension of Aldi from a discount grocer to a more central player in the supermarket space.
Metcash’s problems also can’t be blamed on Woolworths’ recent attempts to invest in pricing in order to get back into the game.
Metcash-supplied supermarkets have been struggling – and losing market share – for years. Most of Coles and Woolworths market share gains for five years are said to have come at the expense of Metcash and the independent grocers it supplies.
A survey by consumer advocate Choice this week found IGA was the most expensive of the four supermarket chains as the same basket of goods cost 8 per cent more than at Coles.
For Metcash even matching shelf prices with Coles and Woolworths would involve a very expensive investment – particularly when it is starting so far behind.