Metro recently reported $3.77 in diluted earnings per share for the 2nd quarter of 2013 or realized net earnings of $366.8 million. Most of the profits coming from the sale of its investment intrest in the convient store chain "Couche-Tard". If you exclude this extraordinary item, income from continuing operations comes in at $100.5 million, which is a subsequent increase of 4.4% from $96.3 million from a year ago quarter. A good takeaway from this is that, even in a highly competitive market, Metro is still able to grow earnings.
For the Full Fiscal Year of 2012, Metro was able to book a 5.4% increase in sales, and a 18.3% increase in earnings. But, if you were to exclude the extra week in the FY2012, you will arrive at a 3.4% increase in sales from the previous year.
Metro has a fairly high return on equity for a grocery chain at 19.8% for the full fiscal year of 2012, up from 16.6% in the 2011 and 2010. Much better than Loblaws ROE of only 10%, but still behind Wal-Marts Roe of 23.7%. Metro is a profitable company, and financial soundness should not be worried about for the time being.
One important takeaway is that Metro has actually been more profitable based on Earnings per Share in the FY2012 from a year on year % increase, than any of the previous 3 years. In the past 3 years their was much less competition in the grocery retail industry, and even today with significant competition entering the market, Metro is able to turn out even higher profitability.
But, the increased earnings and profitability will be short lived, and will face reality in the FY 2013 and 2014.
Past performance is certainly no indicator of future performance. Although, Metro has done phenomenally well in the past, I still feel as if the full effects of increased competition are still yet to be seen in the upcoming quarterly reports.
There are 2 possible outcomes that I believe will happen in the upcoming earnings reports. Metro's sales will slow down, and earnings will experience a decline, through lower gross margins (Metro's new pricing strategy), and lower sales.
The second outcome could be that Metro grows sales phenomenally well as it did in the FY 2012. But of course, to attract all of these new sales in a highly competitive landscape, Metro would have to give significant discounts on its products. So gross margins would be compressed, and earnings would only grow marginally or stay relatively flat on a Year over Year basis.
Balance Sheet
The company currently trades at a price to book value 2.3 Which is a little bit over the ideal b/p of 2, but still a fair ratio for a company that continues to grow.
The current assets of the company are at $1.28 billion, while current liabilities stand at $1.152 billion. So current assets are just able to cover current liabilities. Most of the liabilities come from the account's payables owing to suppliers of the grocery chain. So, a siginficant liquidity problem is not expected, and is highly unlikely to happen.
Metro, currently has a debt to equity ratio of .27. Making Metro's debt postion solid.
Some notes to make about the debt is that: Metro has large amounts of debts ($300 million) from fluctuating intrest rates. Thus, these debts are subject to market movements in intrest rates, and could potentially pose a risk. Currently, intrest rates are at all time lows, which works in the companies favour.
An point to be made is that, having a very small debt to equity ratio could mean that management is too conservative with its business and not leveraging enough to improve shareholder returns. But, I believe that a low debt policy is ideal.
Company Overview
From the outside, Metro's business model seems relatively simple to understand. They sell food to consumers in their many grocery stores, and make a profit from the sale of those goods. But, the grocery business is far from simple.
Loblaws is an example of a once great grocery retailer falling from grace. It seemed as if nothing could stop this company, and was on its way to be one of the WORLD's biggest grocery chains. What was once a great booming company 8 years ago, is now starting lose market share, with declining profits and increased competition. Thus, making the grocery chain business highly unpredictable for any investor, no matter how stellar the past records have been. What was the chief problem with Loblaws? Too much competiton coming from Metro, Sobeys and Walmart. The recession made things even worse, with price conseous consumers turning over to less expensive grocery retailers, offering competitive pricing that Loblaws simply did not have.
What was really concerning for me is that consumers don't care about brand, and aren't willing to pay a little extra more for shopping at brand name retailers. The chief factor driving sales is pricing of the products. Thus, the competitive advantage that grocery retailers offer is none. Consumers readily move from one grocery retailer to another, and shop not on brand but on price.
Management has caught on to this trend, and has acknowledged the need for competitive pricing in its products.
One of Metro's 5 customer promises, also happens to be the most important one of all: price.
The company has been improving display locations on many of its private labels to give the perception of good value for the customers money.
Also, through reward programs Metro is increasing long term customer satisfaction, and customer stability through their "Air miles" program.
The company has executed fairly well in its pricing strategy against other brand name competitors and has shown through their continued increase in sales.
Market and Competition
"Intensifying competition, the possible arrival of new competitors and changing consumer needs are constant concerns for us."Metro currently acknowdlges the risk of incoming competitors. One competitor with a lot of financial backing would be Walmart. Of course, Walmart is a newcomer to the Canadian Grocery space, and a competitor that Metro has never faced before. How the company will fair in the future, is all dependant on how well you think management will be able to compete with a global super Titan (Walmart). Walmart is a fairly large company, and is willing to make significant discounts to gain market share over the short term, and drive more business. Even if their bottom line suffers. Walmart knows that consumer are looking for the best deals, and with their pricing power, anything is possible. With that being said, Metro should be prepared for price wars with Walmart.
Walmart does have something to offer that Metro does not, and that is online grocery delivery. Walmart delivers right to your front door, non-perishable food items! Walmart is capitalizing on the surge of consumer shopping online, and adding that competitive advantage that grocery retailers simply do not have. Online grocery shopping is still in its early stages, and the long term effects on Metro remain to be seen.
Walmart also garuntees the lowest prices on almost everything. Currently they are running ads against Metro, and convincing consumers that you can get much better deals at Walmart. It is important to note that these ad campaigns have only just started. So the effects of Walmart's competitive pricing on Metro are still yet to be seen. Therefore, I still remain skeptical on the long term earnings growth probability for Metro based on increased competition, and margin compression.
Intrinsic Value
Discounted Cash flow: Using earnings per share of $7.83 for the last 12 months, a 0% growth rate, and discount rate of 11% from a benchmark such as the S&P500, we see that Metro is fairly valued $71.18. Metro is currently trading at $69.52. The intrinsic value factors in no growth for the company. But if the company could continue to grow earnings even through a competitive landscape (at their annual 14% rate), than the company would be fairly valued at $124. But, I dont believe that the company would be able to sustain such massive growth, and a levelling off, or flattening of growth is more likely So I feel that the 0% growth used is a fair estimate of future earnings. What may happen is that earnings might actually decrease year over year, from facts stated in previous paragraphs.
Therefore, Metro is fairly valued in the $70 range, and does not provide enough margin of safety to justify a purchase of the common stock.
I have a long term price target of $70 on Metro common stock. I would recommend holding this company. If Metro is able to maintain sales growth, while still staying relatively profitable, this price target would be revised. But, with an highly competitive lanscape, I dont see that happening.
No comments:
Post a Comment