Australian retail conglomerate Metcash announced its results for its FY2021, ending 30 April 2021, on 28 June 2021. While the results were, overall, very positive, the results presentation was somewhat more contentious than usual.
In top-line terms, statutory revenue came in at $14.3 billion, up by 9.9% on the previous corresponding period (pcp), which was FY2020, ending on 30 April 2020. According to Metcash, if "charge through" sales are included, revenue grew by 10.1% on the pcp. Overall earnings before interest and taxation (EBIT) came in at $401.4 billion, an increase of 19.9%. Net profit after taxation (NPAT) was $239.0 million; NPAT for FY2020 recorded a loss of $56.8 million, occasioned by a write-down of $237.4 million to compensate for the loss of a contract with 7-Eleven by Metcash's food business.
Metcash's hardware business also reported strong numbers. Sales including charge throughs came in at $2.6 billion, an increase of 24.7% over the pcp. EBIT for hardware came in at $136.0 million up by 61.5% (though this includes earnings from acquisitions, which we delve more into below). Like-for-like (comp) sales rose by 11.4% in what Metcash defines as the "the retail banner group", while in the pcp this number fell by -0.7%.
In its other segments, Metcash's food business saw sales grow by 3.1% to $9.4 billion. In its liquor segment, sales came in at $4.4 billion, an increase of 19.2%.
Results in csv file
In the face of what would seem to be good news, it was, perhaps, a little surprising to find the analysts virtually attending the results presentation had some pressing questions for management about its internal investment plans, and exactly what the results meant. The initial presentation of the result numbers took around 30 minutes, and the Q&A session took over 40 minutes.
At the heart of this contention was what many analysts saw as a surprising move by Metcash: a share buyback scheme. In announcing this buyback, Metcash stated:
On 28 June 2021, Metcash announced that it is undertaking an Off-Market Buy-Back of up to approximately $175m. This follows the Board's assessment of Metcash's ability to distribute excess capital to shareholders having regard to: an improvement in the level of economic certainty; its near-term capital expenditure and working capital requirements; opportunities to grow and create shareholder value; while also maintaining a strong balance sheet with low gearing. When combined with $179m of ordinary dividends in respect of FY21, Metcash will have returned over $354m to shareholders since payment of the FY20 final dividend.
The Board considered various alternatives for returning excess capital and determined that the Off-Market Buy-Back is the most tax effective and value enhancing strategy for distributing the excess capital. All shareholders who continue to hold shares following the Buy-Back, irrespective of whether they participate or not in the Buy-Back will benefit through earnings per share and return on equity accretive outcomes.
The buyback would account for something over 5% of the shares currently issued by the company.
HNN can make a good guess at what was actually disturbing to the analysts about this move (though it was never overtly mentioned). However, it is best to delay that until our end analysis.
We need first to take the questions of the analysts at their (very valid) face value. For the most part, these related to the wisdom (or lack thereof) in returning capital to shareholders via a buyback, when those funds might have been better reinvested in Metcash.
There were some really excellent questions asked of Metcash, in particular by Grant Saligari of Credit Suisse, Michael Simotas of Jefferies, Andrew McLennan of Goldman Sachs, and Craig Woolford of MST - as well as a seemingly simple, but very revealing question by Morana McGarrigle of Macquarie.
However, as has often been the case, it was David Errington of Bank of America Merrill Lynch who really got to the heart of the matter with Metcash CEO Jeffrey Adams. What makes Mr Errington's questions so distinctive, is that, while they deal overtly with numbers, forecasts and decisions, they somehow also penetrate down to the character of the executives - and of the business itself - involved in making choices.
Mr Errington's question begins by pointing out an interesting fact not at first clearly evident in the numbers supplied by Metcash:
In the second half, your key [food] business in EBIT was down second half [FY2021] on second half [FY2020]. Now, I know that you've lost Drakes and that, but at the end of the day, that's what it is, it is what it is, you lost a couple of major customers here and you have to cycle it. [Also] you're not going to have tobacco excise benefits this year.
So you're down from $94.3 [million] to $89 [million]. And you're going to give up another ten [million dollars] in not having excise from tobacco in food. So my question is in the main food area, is my concern in the industry is that there seems to be a step up in capital intensity going on at the moment, where we have got Woolworths, and we've got Coles both stepping up sizeably their investments.
Is it wise to, you know, because your maintenance capex, I think you're basically highlighting that your capex is not much above maintenance. So I think capex is about $80 [million], and maintenance depreciation is about $60 [million]. So you're a little over that. Now, I know you're doing MFuture and all the rest of it. But giving money back to shareholders at this point, I know there's been a desire to give it back because he did raise $330 million last year, so [you've] got to give some back. I get that. But giving it back like this, when the others are stepping up sizeably their capital intensity... You know, Woolworths has announced last week, $400 million in another automated DC. Coles are stepping up, they're investing in projects. Do you think that you might need to step up to remain competitive? Because I know that you're saying that you've got to look at sales, excluding Drakes and all the rest of it. But at the end of the day, they are major customers that you lost. Are you at the position now that you can actually grow sales, once we do go through the normalisation period, given what's happening in the industry right now?
Mr Adams responded:
Yeah, well, look, Dave [sic], I wouldn't want to try to predict any further than what we've, what we've reported here on the first eight weeks. But again ... we're quite confident that, you know, we are still seeing again, if you go back to that, FY20 being a more normalised sales period, the growth that we're seeing against that is encouraging.
As far as our plans, and you know, do we have the capital that we need for those plans? We're absolutely sure that everything that we spoke about at the investor day, I don't want to comment on what other people are doing, because I'm not, you know, familiar enough with their strategy, and why they're spending that kind of money. But we feel quite comfortable that we're spending the right level that we need to spend to deliver the plans that we've outlined.
Mr Errington took up those points:
Is it fair, Jeff, to compare it to FY20? Do you reckon right now, we're in a normal period, that you're comparing a normal period to a normal period? Because I don't know about you, but living in Melbourne in the last two months hasn't been normal. I've had to wear face masks in supermarkets. I wasn't allowed to go more than five kilometres for about two or three weeks. So do you really think it's fair comparing the numbers today? Do you think we've normalised today, do you? Do you think we've normalised that you can safely say and talk to us as, as the investment community, "compare yourself to FY20, because right now, it's normal versus normal"? Do you think that's right? Do you think we're in normal conditions right now, so that your trading is normalised?
Mr Adams confirmed that this was, indeed, his basic approach:
Compared to FY21 at that time, I think we probably are closer to normal. Maybe this is the new, new normal. The only reason we provided both of those, Dave, was so you can make that comparison to see, versus FY21, which was very volatile, we know, particularly at the start of the year. And then as we got more toward the end of the year, it was sort of what people are calling the new norm.
Mr Errington asked for a final clarification:
But do you think it's the new norm now? Does it seem like we're still in that new normal period now?
Mr Adams agreed that this was his approach:
Yes, I do! And until things change, as far as borders opening up, and people getting further into the vaccination, I think we probably will be living the way we are now for some time to come.
One reason why this exchange matters so much is that it touches on one of the key strategic matters for the hardware industry, as well. In terms of capital intensity (to borrow Mr Errington's phrase), we're seeing something similar in hardware, with Bunnings not only investing in ramping up Adelaide Tools to a nationwide chain of tool retailers, but also buying Beaumont Tiles as well. And behind that, there is the ongoing, very large investment in data analytics that Wesfarmers managing director Rob Scott has instigated. While TTH (Total Tools Holdings) certainly is an investment in hardware, it's also a new business, rather than an ongoing investment in, for example, IHG.
This is happening against an economic background that many would agree is highly uncertain - as Mr Errington points out. Mr Adams, in contrast, seems to suggest there is a predictable pattern to it, a pattern which will, it would appear, continue to benefit the businesses that make up Metcash.
More concerning, however, is that there is a sense in all of this that Metcash may be, at least in part, willing to return funds to shareholders based not only on present performance, but also on future performance. Yet if we look at a venture such as TTH, much of the predicted growth has an element of risk to it. That's part of the point that Mr Saligari was trying to make when he asked some pressing questions about TTH:
Just on the total financial commitment into Total Tools, at the moment, and maybe we just stick with the balance sheet amounts at the close, before talking about the additional 15%. So when you acquired this 70%, it was $57 million for Total Tools Holdings, and you recorded a liability of $122 million, and then there was $42 million dollars, I think, for the JV stores and a liability of $69 million for put options that the JV owners have back to Total Tools. And there was debt $40 million at acquisition. Is that ... sorry, can you maybe just confirm whether they're the right numbers?
Metcash's chief financial officer, Alistair Bell, did respond to that question, but it was not quite on-topic, so Mr Saligari pursued clarification:
All right, to just to, say, double confirm whichever way we cut it, whether we halve the liability or not, we're looking at about $180 million, approximately Total Tools Holdings, about $120 million for the JV stores, including the put options, so we're up to $300 million there plus the debt. So it is sort of $340 [million] or $360 [million], whichever way you look at it, should we then get in? So we should compare that amount with the $24 million? Is that approximately right?
Mr Bell responded:
I'm trying to follow your maths, Grant. So I'll have to, it may be easier to take it off and come back to you afterwards.
Finally, as the last question to the event, Ms McGarrigle asked:
Maybe just one other quick one on hardware, just given your positioning in the trade market and given the fact that the market is very fragmented. Should we be seeing more consolidation? Or should we expect to see more consolidation in the industry in the near term?
Mr Adams replied:
So, you know, we've said before, and we said again at the investor day in March that it does tend to still be quite a fragmented market, in hardware. Obviously, we've had a great opportunity to pick up Total Tools, and in the past picked up HTH. There's still lots of people out there, you know, it would depend now on what valuations they would be looking for, because a lot of people have benefited significantly during the COVID times. So unless people are willing to talk about normalised earnings, we wouldn't be interested. But it is still one of the markets for us and in businesses where it's still very, very fragmented and lots of opportunity.
That's a revealing answer, in that it indicates the drive to acquire more corporate stores is likely to be muted for some time. It's also interesting that when it comes to investing in new stores, the prediction for future growth would seem to be less than completely optimistic.
Assessing hardware at Metcash
At this point, having spent considerable time looking through the financials presented by Metcash for its FY2021, HNN has to confess that we have, quite frankly, been defeated. We cannot, based on the numbers provided, derive an analysis from the perspective of the industry itself.
That isn't to necessarily criticise Metcash. Corporations produce accounting numbers for three purposes: to substantiate their tax payments; to inform investors about past performance and future prospects; and to help with the management of a company by monitoring its performance. The first two are public and the third is private. HNN's purpose is frequently to somehow derive a sense of the third from the numbers contained in the other two.
This year, however genuine performance figures seemed a little hard to come by.
Revenues including charge throughs
To give some idea of the difficulties involved this year, take, for example, the numbers provided by Metcash for revenues that include what the company describes as "charge throughs". On the Metcash website these are defined as follows:
Charge through is a process that allows suppliers to deliver their non warehoused goods directly to our customers, with all accounts for those deliveries payable by Metcash. Metcash, in turn, on charges the receiving customer of those deliveries.
In the most recent, full-year FY2021 results, this is the description of revenues for the hardware segment at Metcash:
Hardware sales (including charge-through) increased 24.7% to $2.6bn (FY20: $2.1bn) with significant growth in DIY sales and a return to growth in Trade.
In the statements for the first half of FY2021, this is the statement for the same category of revenues:
Hardware sales (including charge-through) increased 20.6% to $1.3bn (1H20: $1.0bn) with significant growth in higher margin DIY sales. Excluding acquisitions, hardware sales (including charge-through) increased 16.2%.
So, interestingly, the retail sales including charge through were split exactly evenly (at least when rounded to the nearest $100,000,000) between the two halves.
For the previous year, FY2020, this is how the same category of sales is described in the results announcement:
Hardware sales (including charge through sales) decreased 1.3% to $2.08bn (FY19: $2.10bn) reflecting the impact of the slowdown in construction activity on Trade sales and the loss of a large HTH customer in 1H19.
Going back to the first half of FY2020, this is the description for that category of sales:
Hardware sales (including charge-through sales) declined 4.2% to $1.04bn (1H19: $1.09bn) mainly reflecting the impact of the slowdown in construction activity on Trade sales.
Once again, the amount of sales in the first and second halves were exactly the same, rounded to the nearest $10,000,000.
For FY2019, there was some variance between the two halves.
HNN has no further comment to offer on this.
Organic versus inorganic growth
In providing an overview of Metcash's Independent Hardware Group (IHG) from an industry perspective, it's crucial to be able to separate organic growth, which relates to growth in assets owned for more than a year, from inorganic growth, which relates to recently acquired assets.
The reason that is so crucial is because we're more interested how individual retail premises operate, and less interested in who specifically owns them or benefits from their wholesale business. From an investor perspective, both are interesting, but who benefits from the revenues is somewhat more important.
Crucially, when the market expands, as it has recently, we want to know which sectors are capturing more marketshare. Is it IHG, other independent groups, or is Bunnings the main beneficiary?
In the current results, as provided, there is simply no way to work out, or even back into those numbers. We do get one hint, in the FY2021 first half results, which state:
Excluding acquisitions, Hardware sales (including charge-through) increased 16.2%.
Though, in the same document, when it comes to EBIT, we're back to no differentiation:
Hardware EBIT increased $25.6m (+ 65.8%) to $64.5m, reflecting a significant increase in sales volumes, the increased weighting of higher margin DIY in the sales mix, an increase in the contribution from joint ventures / company-owned stores, and the earnings from acquisitions which included $4.8m from two months of trading in Total Tools Holdings.
The same holds true for the full year FY2021 results. Regarding sales, these state:
Total IHG sales (excluding Total Tools) increased 17.9% (FY20: -1.3%).
When it comes to EBIT there is even less clarity:
Hardware EBIT increased $51.8m (+ 61.5%) to $136.0m, reflecting a significant increase in sales volumes, an increase in the contribution from company-owned / joint venture stores, and the earnings from acquisitions which included $24.0m from the Total Tools Group.
The difficulty in both cases is that the list of acquisitions is quite extensive. It's also not clear that notations such as "excluding Total Tools" means that everything related to Total Tools is excluded, including Metcash's 36% to 42% share in Total Tools franchise stores, or just the main companies that make up TTH.
The only other recourse that we have to measuring organic growth are the "like-for-like" sales mentioned in the FY2021 results:
Retail LfL sales in the IHG banner group increased 11.4% (FY20: -0.7%), with DIY sales up 25.1% and Trade sales 4.9% higher.
However, LfL (comp) sales tend to understate growth, so using these as a proxy for overall organic sales growth would not be fair to IHG.
About the only statement we have to offer is that the 17.9% growth figure - which does include acquisitions - is close to the overall figure from Australian Bureau of Statistics (ABS) for growth through that period of 18.3%.
A curious addition to the results for FY2021 was an extended comparison to not only the previous year, but also two years in the past:
This includes a 19.4% increase for the ten months ended February 2021 and a 12.3% increase in March/April 2021 sales. Compared with FY19, March/April sales increased 25.4%.
HNN's chart for sales over this period illustrates why such comparisons might be tempting:
After a strong peak in activity from April to June in 2020, stats since February 2021 show signs of decline in hardware retail revenues. Nonetheless, as these stats show a 21.5% increase from April and May 2019 to April and May 2021, the IHG sales figures show a stronger result - though they are described as being ex-Total Tools, but inclusive of other acquisition revenue, and thus do not describe purely organic growth.
This multiple year comparison is carried over into the Outlook section of the results dealing with hardware:
In Hardware, sales for the first eight weeks of FY22 increased 29.1% compared with the same period in FY20, and 15.5% compared with the same period in FY21. Total IHG sales for the first eight weeks of FY22 are up 15.1% compared with the same period in FY20, and 3.1% compared with the same period in FY21.
Again, the sales numbers are footnoted as excluding TTH sales, but not other acquisitions.
An announcement that Metcash made in February 2021 to the Australian Stock Exchange regarding the employment of its CEO, Mr Adams, states in part:
Metcash Limited (ASX:MTS) today announces that the employment agreement of its Group CEO, Jeff Adams has been extended subject to the renewal of his visa, which is due to expire in August this year.
The existing terms of his employment agreement are unchanged and include a maximum period equivalent to his visa (four years), and a notice period of 12 months for both Mr Adams and Metcash.
Mr Adams has held the position of Group CEO since December 2017.
As Mr Adams has been a very effective CEO, it will be interesting to see how his ongoing engagement with Metcash develops.
The Remuneration section of the results for FY2021 provides this useful graph which describes the various performance reward schemes provided to key management personnel (KMP).
The long term incentive (LTI) scheme relies on two main performance measures, returns on funds employed (ROFE), and total shareholder returns (TSR). Payments are, according to the document:
Delivered in Performance Rights. Each Performance Right is a right to acquire Metcash shares at no cost, subject to the satisfaction of performance and service conditions.
As expected, the announcement of the share buyback by Metcash has helped to boost its price.
What resonates most with HNN in looking at these results are the comments made by Mr Errington. There is a link, really, between what happens in some sports, and what happens in the relationship with share markets as mediated by corporate executives and investment analysts. The written rules of the game are important, but it's knowledge of the unwritten rules that leads most players to a better understanding of themselves and their team members, and helps some to achieve some small moments of actual greatness.
If it was Metcash's intent to avoid a certain kind of scrutiny, a clear benchmarking of performance against industry statistics (though we can't know if that is the case), then congratulations are due, as from HNN's perspective at least that is what has happened. But constrained results are unlikely to serve Metcash's better purpose in the years ahead. Which is, in the end, the message the investment analysts at the results presentation might have wished to convey - in HNN's opinion.
Related: Metcash held its Investor Day earlier this year.
Metcash/IHG Strategy Day 2021 - HNN Flash #38, March 2021