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Can Metcash outperform Woolworths via a spin-off?

Brendon Lau
metcash share price

The big question facing the supermarket sector in 2020 may not be about rising food prices but whether Metcash Limited (ASX: MTS) will join the spin-off parade.

Two of the sector’s supermarket giants Woolworths Group Ltd (ASX: WOW) and Coles Group Ltd (ASX: COL) have been involved in a divestment exercise within the last 14 months and the struggling grocery distributor may be tempted to follow suit.

Share price catalyst

Divesting assets have been a winning strategy for most ASX companies. Shares in Wesfarmers Ltd (ASX: WES) and Coles have rallied strongly since their separation, while Woolies’ decision to divest its pubs division also probably gave the group a boost.

There’s a case building for Metcash to spin-out its grocery business, at least according to Credit Suisse.

That would sound like radical surgery given how significant the grocery business is to Metcash, but the broker doesn’t think this should dissuade management from at least thinking about the move.

Grocery check-out

“We don’t see an easy solution to the heavy risk weighting that the market applies to MTS’ Food pillar,” said Credit Suisse.

“In our view, there are in-built structural reasons for under-performance that are unlikely to be resolved by operational initiatives.”

Metcash is forced to invest heavily if it wants to keep playing in this field as its competitors have been pumping capital into store refurbishments, supply chain automation and analytics.

Metcash’s 20% rerate

“A left-field solution might provide a win/win for retailers and shareholders,” said Credit Suisse.

“Whilst not a perfect solution, the sale of Food Distribution to retailers would achieve a better alignment of interests and probably facilitate a higher level of investment in the food pillar.

“We estimate that MTS shareholders could potentially benefit from a 20% valuation rerate.”

Standing still means going backwards

What might also spur management to give the spin-off serious thought is the cost of doing nothing. Under an optimistic scenario, the Metcash share price might hold its ground or deliver modest gains.

But there’s a real risk that the stock could also slide further backwards given that it’s fighting larger competitors who have distinct market advantages over Metcash.

Credit Suisse upgraded its recommendation on Metcash to “neutral” from “underperform”. The broker has a price target of $2.64 on the stock.

The post Can Metcash outperform Woolworths via a spin-off? appeared first on Motley Fool Australia.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Wesfarmers Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. 2020