Metcash Ltd Investment Plan: To Potential Investors

1. Introduction

This report will identify the financial strengths and weaknesses of Metcash Ltd in order to give an investment suggestion to potential investors. Metcash Ltd is a wholesale distribution and marketing company specializing in grocery, liquor and hardware. It owns IGA Distribution, Australian Liquor Marketers, Campbells wholesale and MITRE 10. In this report, it will be compared to two other competitors, which are Woolworths Ltd and West farmers Ltd, by examining their three years annual report figures (2008-2010). The limitation of this report is that there is no other company share exactly the same market with Metcash. However, Woolworths, West farmers and Metcash still have significant similarities in terms of grocery retails, which make certain comparisons meaningful.

Also, this report will take the industry statistics, market information, media comments and other relevant information into account while analyzing the company. The recommendation is that Metcash is a preferable long-term investment choice. This idea will be fully explored later through four sections--General, Profitability, Efficiency and Risk.

2. Conclusions

This is the list of financial strengths and weaknesses of Metcash Ltd.

Strengths:

* Metcash outperforms the overall retail industry in the previous financial year, with 4.88% lift in Metcash's sales against 1.71% growth in retail turnover.

* Metcash has efficiently managed its debtors, inventories and creditors. All of the three efficiency ratios are on a reasonable and acceptable level.

* The liquidity of Metcash is controlled in a satisfying level with a current ratio of 1.36:1 and a quick ratio of 0.85:1 in 2010.

* In terms of market-based ratios, Metcash is a preferable choice with lower P/E ratio and higher dividend yields in comparison to its competitors.

* There is an increase in net profit margin and sales for Metcash in 2010.

* Metcash's interest and finance expenses are well covered.

* The expense--administrative costs is decreasing.

Weaknesses:

* Metcash has lower gross profit margin and net profit margin than its competitors.

* In terms of ROA and ROE, the figures sit between the results of Woolworths and West farmers, which indicating that it has medium profitability level.

* Metcash has a high level of gearing with a leverage ratio of 2.64, which is probably too risky.

* Metcash has low cash flow comparing to its competitors.

3. Recommendations

Given the current harsh market climate, Metcash is adapting well by taking short and long-term measures, which results in an increase in sales and net profit. The recent acquisition of Franklins will also increase its future profitability. Besides, it has preferable market performance, liquidity and reasonable efficiency ratios. Therefore, it is a good long-term investment choice.

4. Discussions

4.1 General

4.1.1 Industry figures

According to data from Australian Bureau of Statistics, the food and hardware retail sales has gone up by 1.71% in the 2009-2010 financial period (Appendix 1). In the same financial period, Metcash has a 4.88% lift in sales which outperforms the industry average. Also, its market share is raised up to 19.9% in 2010 (Appendix 3). These information indicate that Metcash is doing well during the previous financial year, given the deteriorating economic climate. The retail industry Metcash is in (Though Metcash is a wholesaler, wholesale and retail do not have much difference in this case.) is going through a difficult period with no increase in selling-price, but increasing costs. " This year, we've had to pay higher interest rate, higher petrol prices and there is no government stimulus payments ( Fullerton T 2010 -- Appendix 6)," said by Andrew Reitzer (Metcash's CEO). However, Metcash adapts well in this tough situation by trying to drive internal costs down, which results in 12.4% lift in annual profit and 4.88% growth in sales.

4.1.2 Market-based ratios

The following market-based ratios are good tools to examine the market performance of Metcash, especially when compared to its competitors. The P/E ratio measures the amounts market will pay for $1 of profit (Bazley M & Phil H 2010). For investors, a lower P/E ratio is preferable as people can purchase more shares. Using the market price on 8th OCT, the P/E ratio for Metcash is calculated to be $14.59. In comparison, Woolworths has higher ratio of $18.11 and West farmers gets $25.06 as the P/E ratio. Dividend Yield measures the current yield on dividend (Bazley M & Phil H 2010). Normally, the higher the Dividend Yield, the more preferable it is for the investor. Metcash has a higher yield of 6% in contrast to 3.9% for Woolworths and 3.75% for West farmers. In this case, the low P/E figure and the high dividend yield make Metcash appear to be a preferable choice.

4.2 Profitability

Profitability ratios assess the ability of the business to generate profits. By examining the following ratios, a general picture on whether Metcash is profitable or not can be captured.

The gross profit of an entity indicates its ability to control the level of cost of goods sold relative to sales. The higher the percentage, the more the business retains for each dollar of sales. Metcash sees a decline in gross profit margin from 10.41% to 10.10% in 2008-2010 financial years, and the figures are significantly lower than its competitors. Woolworths shows an average of 25% while West farmers sits around 31%. This evident difference can be attributed to the difference in the bargaining power of each organization with suppliers. Woolworths and Coles make up 70% of the grocery segment, which gives them the power to screw suppliers down on price and therefore higher gross profit margin (Appendix 7). Metcash, on the contrary, does not have such ability. Also, this two grocery retail giants are fighting on a price-cutting war in order to earn more market shares, which creates food deflation (deflated