New Metcash boss to walk into crossfire of the supermarket battle

STEPHEN BARTHOLOMEUSZ
July 11, 2017
The Australian
Metcash’s new chief executive, former Tesco executive Jeff Adams, will inherit two businesses in quite different transitions when he succeeds Ian Morrice as Metcash’s chief executive in December.
One of those businesses, Metcash’s expanded hardware operations, ought to be on a very positive trajectory. The other, its core food and grocery division, is in a continuing struggle for survival.
Morrice, who has clocked up five years as Metcash CEO, has done a fair job of at least stabilising what was a rapidly shrinking supermarkets sales base while taking advantage of Woolworths’ exit from its disastrous foray into the home improvement sector to pluck Home Timber & Hardware from the wreckage and double Metcash’s base in the sector.
The supermarket sector, however, is one where the goalposts are continually shifting away from Metcash and the independents it supports, as Coles and Woolworths throw ever-increasing investments at price and service, while the integration of Metcash’s Mitre 10 hardware operations with the Home Timber & Hardware business acquired from Woolworths is a work-in-progress.
The torrid conditions in the supermarket sector created as Woolworths has regained its competitiveness by ploughing more than $1 billion into prices and service over the past 18 months — forcing a perhaps slightly belated response from Coles, which is now very significantly stepping up its own investment program — has exposed Metcash to their crossfire.
Morrice, sensibly, was prepared to sacrifice earnings to maintain the competitiveness of his independents and improve the quality of their offers.
While last year’s results showed he had stemmed the decline at least for that moment, the cost of that achievement was reflected in a 21 per cent decline in the division’s earnings before interest and tax (EBIT). In the first half of this year there was a further four per cent decline in divisional EBIT.
With the battle between the two big operators apparently intensifying — Coles’ John Durkan said last month that Coles is trebling its investment in price and service after Woolworths’ same store sales growth outstripped Coles’ in two successive quarters — Aldi continuing to expand and Amazon somewhere out there on the horizon, Metcash will continue to experience fierce pressures on its food and grocery earnings.
The hardware story is more promising. Metcash has forecast $15 million to $20m of synergies by the end of the 2018 financial year from the acquisition of Home Timber & Hardware for $165m last year.
Moreover, the demise of Masters has left Metcash as the second-largest player behind Bunnings in a sector where there are only two truly large players.
Now that the disruption generated by the horrendously costly Masters experience and Woolworths’ messy exit from the sector is behind it, Bunnings is likely to be a very rational dominant player.
Its own expansion into the UK hardware sector, which has generated its share of sceptics, is a long way from the point where its success, or otherwise, is measurable. Wesfarmers is pursuing a five-year $1bn-plus plan to establish itself properly in that market.
In the meantime, particularly as Coles’ earnings will remain under pressure from the relentlessly competitive nature of its environment now that a far more focused Woolworths has regained its competitive instincts, Wesfarmers will be keen to maximise the earnings from Bunnings’ core Australasian base.
With the opportunity to restore margins (now that Masters has been wound up) and a sales base about six times that of the enlarged Metcash, it isn‘t in Bunnings interest to try to squeeze Metcash, which should give Adams the opportunity to complete the merging of the two operations and retain the synergies in a more stable and profitable market.
The other positive element of his inheritance is a stable balance sheet after Morrice and his board took what would have been a tough decision last year to sell one of their better businesses, Metcash’s automotive division, to Burson Group for a net cash injection of $242m that, with other sales and lower capital expenditures, dramatically reduced the leverage in the group’s balance sheet.
With the Home Timber & Hardware deal majority funded with equity, Metcash has net debt of less than $200m with no significant maturities until the 2019 financial year, giving Adams stability, flexibility and time to develop and implement his own strategies for the group.
Adams’ CV at Tesco, where over two decades he held a range of senior roles in its overseas operations (Turkey, Thailand, the US) as well as the UK, suggests he likes a challenge. He’s got one.