Metcash and IGA on a slippery slide as chairman pumps up buyback

Simon Evans
July 4, 2018
Financial Review

The chairman of struggling grocery wholesaler Metcash says a $125 million off-market buyback will benefit all of the company’s shareholders whether they choose to be part of it or not, as fund managers warned that the supermarkets business is facing serious strife over the next five years.

Metcash chairman Rob Murray has sent a letter to shareholders which accompanies the details of the $125 million off-market buyback, with a draft class ruling from the Australian Tax Office outlining that for tax purposes, the buyback price will comprise a capital component of 61¢. The $125 million buyback will reduce Metcash’s issue capital by about 5.3 per cent.

Shareholders wanting to participate in the buyback can offer to sell some shares to Metcash under a tender process at specified discounts at between 8 per cent and 14 per cent to the market price.

Watermark Funds Management head of consumer research Ian Carmichael said the hardware and liquor divisions of Metcash were solid performers, but the core grocery wholesaling business faced a tough future because underlying earnings from that business have been going backwards for the past two years and there were even more problems ahead.

“It has some very serious issues,” Mr Carmichael said. If current trends continue the grocery part of the business may not be making any profits at all five years into the future, he said.

The growing strength of Aldi in South Australia and Western Australia had been a big drag for Metcash in those states. “Aldi is really what’s hurt them,” he said. This has been against a backdrop of already fierce competition from supermarket majors Woolworths and Coles.  Aldi now generates about $8 billion of sales in Australia.

Shares take a hit

It was difficult for Metcash to influence the consistency of the IGA supermarket offering, with the brand being uneven. “There are some very good ones and there are some poorly presented ones,” Mr Carmichael said.

Metcash operates Mitre 10 and Home Timber and Hardware in the hardware sector, which both have a bigger skew towards trade customers than walk-in retail customers like industry giant Bunnings.

“That makes it a bit more cycle but it’s a good business,” Mr Carmichael said.

Wilson Asset Management portfolio manager Matt Haupt said there were serious flaws in the Metcash business model, because grocery prices had dropped so low in a highly-competitive market leaving little room for both a wholesaler and an independent retailer to extract a margin. “The model is flawed at the moment. Two people need a margin and it’s just not there,” Mr Haupt said. On-shelf prices had been dropping at Aldi, Coles and Woolworths and there was not enough fat left for two different sets of people to clip the ticket in the grocery wholesaling model.

The exodus of the Drakes supermarket chain in South Australia in May as a wholesale customer of Metcash triggered a hefty plunge in the Metcash share price. It was at $3.68 on May 25, and is now sitting at $2.66. Drakes is moving to a self-supply arrangement from mid-2019 and spending $80 million on a new hi-tech distribution centre in Adelaide’s northern suburbs.

Drakes won’t comment on whether it intends trying to lure other independents as customers to be supplied from its new distribution centre. Mr Carmichael said the sheer size of the plans had led many to believe it wouldn’t be only a self-supply arrangement.

“The suspicion is they are going to offer that as a competing service”.

Jeff Adams, a former Tesco executive who took the helm in December at Metcash from Ian Morrice, has a strategy of investing more into fresh food and ready-to-eat meals, new smaller format stores and refurbishments of bigger IGA supermarkets.

Retail sales across the IGA retail network declined 0.9 per cent on a like-for-like basis for the 12 months ended April 30, 2018. 

The Metcash off-market buyback booklet states that the tender period opens on July 16 and that the final buy-back price and any scale back will be announced to the ASX on August 13.

“We believe the buyback will benefit all Metcash shareholders, whether or not you participate, due to the expected improvement to earnings per share resulting from a reduction in the number of shares on issue,” Mr Murray said in his letter.

Mr Murray said Metcash had enough balance sheet capacity to return funds to shareholders and to be able to invest in its future growth strategy.

Mr Carmichael said the buyback was a method ensuring earnings per share growth, but Metcash needed to add another growth business to its portfolio to sit alongside hardware and liquor, because grocery wholesaling to independents would keep suffering structural problems.