Australian wholesale and retail conglomerate Metcash, owner of the Independent Hardware Group (IHG) and Total Tools Holdings (TTH), reported results for its first half of financial year 2022 (FY2022H1) on 6 December 2021. The results cover the timespan of 1 May 2021 to 31 October 2021.
For Metcash overall, sales revenue for the reporting period was $7151 million, up by 1.3% on the previous corresponding period (pcp), which was FY2021H1. (Including charge-throughs, the figures are revenue of $8.2 billion, and growth of 1.5%.) Net profit for the period was $129 million, up by 3.0% on the pcp.
The company's food business saw sales fall by 4.9% to $4022 million (though excluding the loss of its Seven-11 contract, the fall was only 0.2%, according to Metcash). Liquor sales came in at $2170 million, an increase of 6.6%.
Metcash chief financial officer, Alistair Bell, announced that the company expects to acquire an additional 14 joint venture (JV) TTH stores in December 2021.
Hardware
When it comes to properly assessing the success of the hardware segment of Metcash for the reporting period, a number of obstacles present themselves. There is, first of all, the influence of the COVID-19 pandemic, which resulted in the acceleration of hardware retail sales, and dominated almost all other factors, including seasonality, up until the present year.
Hardware retail sales environment
In fact, recent statistics indicate something of a return of seasonality. Chart 1 shows the pattern for retail figures for all Australia:
The pattern the chart shows from August 2017 up to February 2020 also holds true for the previous five years as well: a peak in sales reached during the final quarter of the year, followed by a steep fall to February, a local high recovery in March, then a continued decline through the second quarter. The third quarter shows a gradual climb back towards the high reached in October.
From March 2020 onwards that pattern was disrupted. That March saw a strong spike upwards, which continued to a new high for sales in May 2020. This declined to a local low in August 2020, and then the old pattern of a peak high in the final quarter of the year repeated, but at a much higher level. That older pattern continued through to July 2021, still running at that higher level, with an additional $300 million or so in sales each month. In August 2021 the upwards spike of the old pattern repeated, but to a level about $90 million higher than the previous high in December 2020.
This return to seasonality can be seen clearly in Chart 2, which compares each year of hardware retail sales Australia-wide:
In terms of the reporting period for Metcash, Chart 3 indicates the percentage change when comparing each month to its previous corresponding month:
As this graph shows, during the reporting period the first three months (May to July) showed negative growth, while the final three months were mildly positive. Only the Australian Capital Territory went strongly negative, while Victoria remained consistently slightly negative. Australia-wide the result was net negative growth for the period of 2.5%.
The hardware numbers
That's the background, which is complicated enough. However, the numbers provided by Metcash for its hardware segment also have their own complexities.
The two main numbers that are used to assess the operations of a retail company are its revenues and its earnings before interest and taxation (EBIT). Net profit after tax (NPAT) is also important, of course, but it can be affected by a range of factors outside the company's control.
Generally speaking, while the overall numbers for revenue and EBIT are important, it's also important to find what has come to be called the "organic" numbers. These relate to the operations of the company absent the effects of acquisitions and demergers/spin-offs.
For example, if a company sells off one of its divisions for a great price, in the next company reports the revenues from that division will be missing, so it will record a steep drop in revenue. Obviously, that is not a sensible number. So after such a sale, companies provide historical revenue numbers that remove the past revenues of the division that was sold.
Metcash did just that after the sale of its automotive business to Burson Group for $275 million in June 2015. In company reports for FY2016 it changed the revenue it had reported for its FY2015 from 13,626.2 to 13,369.8.
However, when the numbers run the other way, and companies purchase a business so that their revenue and EBIT numbers are grown non-organically, they tend to be somewhat reluctant to simply share the underlying, organic growth numbers.
Such is the case with the revenue numbers from Metcash's hardware segment, which have been affected by the company's partial acquisition of TTH in 2020, and made even more complex by additional TTH-related acquisitions during 2021. Add to that the acquisition of three more hardware retailers, and finding organic growth numbers has become difficult indeed.
To report the topline, fully non-organic numbers for hardware: Sales - including TTH - increased by 17.9% over the pcp to reach $1.48 billion. IHG sales - including the recent acquisition of three hardware retailers - grew by 7.2%.
The numbers for IHG do not seem to be explicitly mentioned, but we can back into something close to them, as total revenue for TTH is listed as $153.5 million, which means, non-TTH hardware sales - which would be close to, but not equal to IHG sales - would be around $1.33 billion. Metcash also states that IHG sales increased by 7.2% (which, again, would include sales from recent retailer acquisitions).
Perhaps the most relevant number is that given for like-for-like (comp) sales, which Metcash states were up 5.6%. However, that number is, according to the results: "Based on scan data from ... 282 IHG stores". Scan data would tend to select the stronger stores in the network, and on a store number basis this represents less than 45% of the total store network (including Mitre 10, Home Timber & Hardware, True Value and Thrifty Link stores).
When it comes to EBIT, Metcash has done a good job in making more information available. The topline number, as provided by Metcash is that EBIT for the current reporting period in hardware was $98.9 million, up by 53.3% on the pcp, which reported $64.5 million in EBIT.
However, that number includes, for the current reporting period, EBIT of $33.1 million for TTH, while the pcp included TTH EBIT of $4.8 million. Further, Metcash states that there was an additional EBIT contribution of $3.5 million from those other retail acquisitions. So, putting that together, organic EBIT would be $62.3 million in the current reporting period, and $59.7 million in the pcp, yielding an organic EBIT growth rate of 4.36%.
While that would not, in normal times, seem like all that great a number, it actually does show good growth. As Metcash reminds throughout its results, and as HNN's charts indicate, this comes not only on top of considerable gains in overall revenue for the past 18 months or so, but also during that down-cycle of hardware revenue.
On the other hand, of course, the numbers from Metcash have also been influenced by inflation, especially on some trade supplies such as lumber. In response to a question on inflation by analyst Tom Kierath of Barrenjoey, Metcash CEO Jeff Adams responded in part:
On trade, just to give you a range, it would probably be in sort of the mid-single digit range on trade, in the first half. It seems, and we said it in the Outlook comments, it's very difficult to predict what we think what's going to be in the second half of the year, because we are seeing some movements up and down, in some of that trade pricing. But we do believe some of it will still be there in the second half, let's put it that way. In trade.
DIY would be lower than that it would be lower than mid single digits on on DIY. But again, it'd be you know, those are not audited numbers.
The CEO of the hardware segment, Annette Welsh, expanded on those comments:
[Inflation] is very focused around the timber part of our business, doors, plumbing, and is linked to the balance of supply versus demand. So there's an uncertainty as to what it would look like going forward.
That's a helpful reminder from Ms Welsh that the inflation being experienced is not due to sources such as currency exchange rate fluctuations, increases in material supply conditions, or cartel activity. This is one reason why inflation is not seen as an imperative negative by economists at the moment. It's largely down to a lack of capacity in shipping, which, unfortunately, will take a year to clear.
As a final note on these numbers, Metcash also stated that, based on figures from all 94 stores, TTH saw comp sales grow by 1.5% over the pcp.
Market characteristics
Metcash was also more forthcoming about how its online sales in hardware have been progressing than it has been in the past, stating that online now makes up around 3% of its total revenue, which is $44 million. Metcash certainly owes Ms Welsh a vote of thanks for that figure, as it was she who pushed hard since 2018 to grow Metcash's online sales capabilities - capabilities that are now being duplicated by the company's other retail segments.
As many predicted, IHG was not able to sustain the high level of DIY sales, with the balance between trade/DIY going to 64/36, where in the pcp it had been 60/40. In the comp sales figures, DIY went down by 0.1%, while trade grew by 8.9%.
According to Metcash, the overall EBIT margin for the hardware segment was 6.7%. The EBIT margin for IHG was 5.0%, while the IHG wholesale margin was 3.0%.
Analysis
The two most pressing questions for the hardware retail industry remain: how long will the current increased sales last, and how bad is the "hangover" going to be after the "party" finishes?
There is one strand of theory that states the market has been permanently altered structurally, and that some proportion (at least) of the increase experienced since March 2020 will remain. A competing theory is that the reverse will happen, and that there will be a severe contraction coming in the market, especially as market demand is set to fall with declines in both birth rates and immigration - both changes where the effects begin to show up two to four years later.
Looking at the current charts for hardware revenue, it does seem as though the actual seasonal demand - the increase in the final quarter of the year - exists somewhat separate to the underlying increase in demand. That underlying increase is likely to be mostly trade building activity, with some DIY mixed in. It's the opinion of organisations such as the Australian Construction Industry Forum (ACIF) that the building demand, given restrictions on supply, will last until the end of 2022, and possibly into the first quarter of 2023.
Mr Adams backed up that view in comments he made on the effects of supply shortages, while replying to a question by David Errington, a senior analyst with BankAmerica:
I think because everybody in the market [is] sort of impacted equally, that what it's doing is really elongating, in hardware, more of the building cycle. Because, would our sales be higher if we could get everything that we're trying to get - absolutely. There's no doubt. But is it lost sales? I don't think it's lost sales, because again, it's a shortage in the market. So what that does do then is just elongate out this this current building cycle, because the builders are just not able to get everything.
One way of looking at the mathematics of this increase is to look at the delta between the highs and lows of the retail revenue cycle. Using ABS stats for Australia, we can see that the average revenue Q4 of the calendar year for years 2017, 2018 and 2019 is $5467 million, which compares with Q4 revenue for 2020 of $6668.5 million, an increase of $1201.5 million, up by 22.0%. The average for Q2 over the same three past years is $5038.9 million, and for 2020 it is $6030.0 million, an increase of $991.1 million, or 19.7%.
Looking back at Chart 1, one possible way of analysing this situation is to see there being a "baseline" of activity at around $1400 million through to February 2020, which is then replaced by a new baseline at around $1700 million from August 2020 onwards.
Market changes
One of the conclusions that we've reached at HNN is that what has shifted is homeowners' relationship to the housing market. We know that there will be various forms of monetary policy adjustment by the end of 2023, especially as regards interest rates. We can expect relatively conservative fiscal policy responses to those adjustments. Yet the decisions homeowners are making have less to do with medium-term investments, and more to do with acquiring security for their families. Buying a larger, better house is all about being able to better cope with adverse outcomes if the COVID-19 pandemic continues through to the end of 2022.
That doesn't mean that consumer spending won't be negatively affected if house prices decline sharply, and some homeowners find their mortgages are "under water" (owing more than the value of the house). But it does mean that it is less likely that decline will be accelerated by homeowners choosing to sell to avoid that decline in value, possibly limiting how deep the decline runs.
Total Tools Holdings
Which brings us, indirectly, to the matter of TTH. One really good question that analysts have asked about TTH and its markets is, what is driving the expansion in this sector? Primarily that is by TTH and the new Bunnings-owned Tool Kit Depot (TKD), but there has also been substantial expansion from retailers such as Sydney Tools as well.
The two main sources of that expansion are increased innovation in power tools, and increased demand for anything that will help builders and tradies achieve better efficiencies in a relatively inefficient industry.
The result of those two forces working together is that the lifecycle in tool systems for tradies has shortened substantially. Just 20 years ago tools were expected to last at least seven or eight years, and potentially ten years if they were looked after. Today that cycle can be as short as three to four years, with tradies replacing their tools at the same time they need to replace their Lithium-ion (Li-ion) batteries. The market as a result has grown by something like an estimated 35% to 40% over the past five years.
Tool companies, in catering to productivity needs, have responded by launching more and more specialised ranges. What was once a market largely divided into 18-volt mainstream tools, and 12-volt subcompact tools, has seen additional categories spring up, including voltages as high as 108-volt, new intermediate ranges of around 36-volt, and compact 18-volt tools. Tradies and builders are desperate to somehow squeeze out the equivalent of an extra hour in the day through more power to do things faster, or with specialised tools that make particular tasks easier.
Of course, the difficulty with that kind of market is that should demand for construction fade out, tradies can very easily switch to not replacing tools every four years, and replace them every six years instead. There are not any external drivers to the demand, such as safety or reliability (many brands have five-year warranties, for example).
The real problem, though, that HNN sees developing with Metcash and TTH is, as we've mentioned in the past, that there is a definite conflict of interest between TTH and the independent stores that make up IHG. The best question from analysts at the results conference call came from Brian Raymond of JP Morgan, who asked:
Just on the Total Tools side. Just interested in that co-location or adjacent store base that you guys are highlighting there. I understand that's one of the first stores of that nature. Just interested in how that looks going forward of the 130 stores do you think there will be a sizeable portion that will be co- located? And do you think there is any cannibalisation of the Mitre 10 when you drop the Total Tools [stores] in there? So just interested in just generally how that impacts foot traffic and sales across the two on a net basis.
The adjacent store that Mr Raymond was referring to relates to a photograph on slide 11 of the results presentation:
The caption on that photograph reads: "Adjacent Total Tools and Mitre 10, Merimbula, NSW. Opened November 2021". That particular arrangement came about after a Woolworths supermarket left its established premises, and a regional Mitre 10 retailer decided to expand into Merimbula. There is another similar adjacency being developed in the town of Wonthaggi in southern Victoria.
Mr Adams responded to the question by stating:
Yeah, so we said from the beginning, this acquisition was quite complementary to the Mitre 10 business, because where in our tool business, there tends to be more DIY type of customers, whereas Total Tools is completely focused on the professional tool, and in tradies.
That one [Merimbula] was a trial for us. It started out very well. And then I don't know, if you want to make some comments on it. We do see opportunities in the network, is it going to be extensive? I'm not sure, I would say extensive, but there are going to be opportunities in that 130 target for us to do some combined sites.
Ms Welsh followed up with a comment of her own:
I think it's an exciting moment in our history, where we've got an opportunity to ensure that we're growing the market. And we're leveraging that market into the vein of Mitre 10, and Home Hardware and Total Tools. So that's the first. And yes, it was always part of the percentages that we thought were available to the network of independents when we brought the two businesses together.
Mr Raymond's references to foot traffic and sales on a net basis are very apt. Because, of course, if you do have conjoined stores, then the Mitre 10 retailer is essentially willing to give up sales of both power tools and power tool accessories in exchange for increased foot traffic, attracted beyond the Mitre 10 store's normal traffic by the TTH outlet.
From a corporate perspective, of course, if almost all TTH stores are going to be wholly owned or JVs in which Metcash has a significant stake, there's actually an advantage to be had in transferring tool purchases from an independently owned Mitre 10 to the TTH outlet. If instead the transfer is between a corporate-owned Mitre 10 and a TTH, in most cases it's going to be something of a "wash".
The difficulty comes in where there are independently owned Mitre 10 stores in a region where a couple of TTH outlets are introduced. The Mitre 10 stores will see a reduction in sales, most likely, and there will be no counterbalancing benefits.
The statement by Mr Adams that "because where in our tool business, there tends to be more DIY type of customers" might mostly kindly be described as somewhat disingenuous. It is certainly true that IHG has more DIY customers than TTH. However it is also true that independent retailers in IHG - and particularly Mitre 10 - have expanded their marketing of trade-quality tools since 2015.
Some evidence for this can be found in the videos that IHG has itself produced, highlighting (during a time of increasing corporate ownership) the "family based" nature of many Mitre 10 stores. A number of these videos feature - as, indeed, do many Mitre 10 stores - gleaming display "pods" of ranked high-end Makita cordless power tools. In fact, this seems to be a regular feature of IHG's Sapphire store upgrades.
Diamond Creek Mitre 10 promotional video:
"Industrial Power Tools" at Beck's Mitre 10 Launceston (TAS):
"Industrial Power Tools" at T&H Mitre 10 Moe: (VIC)
In contrast, the IHG line of tools for DIYers is somewhat lacklustre. It's made up of a bit of Bosch Green (with a larger range available through Bosch's Amazon store), the limited Rockwell brand from Chinese tool powerhouse Chervon, Worx which is also from Chervon, and some Black & Decker "orange" tools.
There is nothing in that lineup that competes, for example, with the Bunnings Ozito line, which offers, for example, the PXC 18V 10mm compact drill driver kit, with a drill, charger and 1.5 Ah battery for $49. There's even a basic Ryobi drill, with 2.0 Ah battery and charger for $99. And with both those tools, the batteries can power a wide range of additional tools.
But this misses a major point about power tool sales: it is just as much about the power tool accessories as the tools themselves. Smaller IHG retailers are not able to compete on price for many cordless power tools with Bunnings, but they do have reasonable sales of drill and impact driver bits, abrasive disks and circular saw blades. It is in that area where the impact of more TTH outlets could be felt most sharply.
Strategic consequences
In HNN's opinion, what we're really seeing in the TTH acquisition is the playing out of certain strategic consequences in Metcash's hardware segment. From the perspective of individual store owners, the amalgamation of Mitre 10 and the formerly Woolworths-owned Home Timber & Hardware (HTH) stores (aka Danks) has not turned out too badly. But from a Metcash corporate perspective, it is probably borderline disappointing.
IHG did a very good job at retaining HTH stores, but the second stage of the business plan, continuing to grow past that point by gaining stores from other buying groups such as Hardware & Building Traders (HBT), simply did not work out. To a large extent, IHG under the guidance of Mark Laidlaw relied as much on emotional arguments as business analysis to encourage membership in the group. It wasn't a winning proposition in the broader independent retailer market.
This meant the large investment made in creating IHG, an investment in capital, effort and opportunity cost, just did not seem to deliver the expected results that had been hoped for. The acquisition of TTH could be seen, in effect, as the next strategic play available to Metcash to make its hardware segment payoff as planned.
There are dual risks that this strategy takes on. The first is whether IHG independent retailers will feel the competition from TTH outlets is unfair, leading them to leave the group. The second is simply that by late 2022 TTH will be directly competing with TKD owned by Bunnings. The ability to leverage the foot traffic created by existing Bunnings warehouse operations is one part of that risk, but the other is that Bunnings is very good at strategic execution in Australia.
Related: Metcash released details of its trading for the first 16 weeks of the company's FY2021/22 year.
Metcash/IHG trading update - HNN Flash #63, September 2021 Related: Metcash's results for FY2021 showed strong growth in its hardware segment.
Metcash 2021 full year results - HNN Flash #52, July 2021
