Metcash's troubled turnaround

Metcash polarises investors. It's the most heavily shorted stock on the market, which means short-term traders are betting the share price will fall. Others believe the company's liquor and hardware businesses justify the share price alone, meaning you're getting the grocery wholesaling business for free.

Yesterday's Investor Day – which we were unable to attend – was new management's chance to show off the progress of the 'Transformation Plan' (read turnaround strategy). After reviewing the presentation materials, though, it all looks like pretty standard stuff – cut prices, invest in fresh food, and improve the private label offering. It might work but the large supermarkets are doing it too.

Metcash's problems remain structural. As a grocery wholesaler, its incentives are to increase sales to cover high fixed costs – hence the decision to open 100 stores this financial year – and to standardise its range. Yet it supplies three very different types of IGA customer: Supa IGA large format supermarkets, small suburban grocers, and semi-monopolistic rural and regional stores. Few of Metcash's small business customers have the resources required to modernise their stores or switch to premium delicatessen-type strategies.

The turnaround strategy is taking place against the background of some significant headwinds too. Aldi is moving into South Australia and Western Australia, which are Metcash/IGA strongholds. Woolworths is likely to create waves in grocery retailing when its new managing director is appointed. And German-owned Lidl lurks in the background, perhaps hoping to pick off prime IGA sites as Metcash's weaker customers exit the industry.

Private equity or perhaps some other company could bid for Metcash but it's not something we'd count on. And while the sale of the automotive distribution business for a net $210m and the cancellation of dividends means the threat of a capital raising has receded for now, debt levels remain too high for comfort. The stock is down 9% since Metcash cancels the dividend from 4 Jun 15 (Avoid – $1.15) and the recommendation remains AVOID.