Metcash: Result 2016

Metcash has been through the wringer since we recommended selling almost four years ago in The Metcash earnings hole on 31 Aug 12 (Sell – $3.69). The hole that we warned about back then has turned into a chasm, with operating profits from the Food and Grocery business more than halving from $398m in 2012 to the $180m announced yesterday for 2016. As a result, underlying earnings per share have tumbled from 34 cents to 19 cents and the dividend has been axed. The share price has almost halved to $1.92 (after falling as low as a dollar).

But is there light at the end of the tunnel? We can't see it. Chief executive Ian Morrice has certainly made some progress with his transformation plan, but the problems we outlined in Metcash model is fundamentally flawed on 24 Mar 14 (Avoid – $2.85) remain. In particular, the company's distribution-focused model means it lacks control over the relationship with end customers.

So while price cuts appear to have stemmed market share losses (as well as crunching the operating margin to 1.9%, from 2.4% last year and 4.3% in 2012), Metcash will have to keep matching the pricing moves of Woolworths and Coles to hold that ground. And dollar for dollar, those moves will have a greater impact on Metcash than they will on its peers. Management underlined the difficulties by talking of highly competitive trading conditions and 'headwinds from competition, deflation and a rising cost base'.

The plus side from the result was that net debt dropped by $392m to $276m, thanks to the disposal of the Automotive business, the cessation of dividends and a (somewhat concerning) 24% reduction in capital expenditure. With its balance sheet in better shape, the company is planning a return of dividends in a year's time and is considering buying Home Timber & Hardware from Woolworths, although we fear this will just be more paper over the cracks. AVOID.