2023-12-11 09:16:03 ET
Summary
- Metro is a Canadian grocer with a track record of steady growth in revenues, cash flow, and dividends.
- The company has increased capex to modernize its supply chain to support the long-term growth of its business.
- Metro's efficient operations and focus on e-commerce and digital capabilities have helped maintain decent margins.
- At 10.4x EV/EBITDA, the company looks undervalued when comparing it to its historical valuation and its competitors.
Investment Thesis
Metro Inc. ( MRU:CA ) is one of Canada's largest grocers with a network of nearly a thousand stores across Ontario and Quebec. With significant investment in capex to build out its distribution centers, the company has focused on cutting costs and being more efficient, something I view as key to driving EBITDA growth in the future. In addition, the company has maintained profitability and margins, which has allowed it to increase its spend on capex. With higher growth potential than its peers and a growing dividend supported by its track record of delivering solid returns above GDP, this boring grocer has all the traits of an investment I would want to own in my portfolio.
business Overview
Metro is one of Canada's largest grocers with a network of 975 food stores under banners like Metro, Metro Plus, Super C and Food Basics, with stores predominately located in Ontario and Quebec. In addition to 645 drugstores operating under the banners of Jean Coutu, Brunet, Metro Pharmacy and Food Basics Pharmacy, the company employs nearly 100,000 people and generates sales of nearly $19 billion annually.
Industry Overview
Metro is one of Canada's top 5 grocers, who collectively make up an 80% market share across the country , indicating that the market is largely consolidated with few peers. Notable rivals include Empire Foods ( EMP.A:CA ) and Loblaws ( L:CA ), the company's larger pure-play competitors.
Being a largely consolidated and mature industry, Canadian grocers compete on price, operating with thin EBITDA margins around 10%. Such fierce price competition has meant that no major player has any significant economic moat against its competitors, as profitability is more of a function of price rather than volume. That said, Metro has done a good job in fending off competition and maintaining its market share in Ontario and Quebec. With the 2018 acquisition of Jean Coutu , Quebec's largest pharmacy brand, Metro has strategically placed itself to grow in the health and wellness space, while creating logistics and cross-selling synergies with its current network.
In my view, this key acquisition narrows the gap between Loblaws, who owns the pharmacy/drugstore banner Shoppers Drug Mart. As referenced through numerous earnings calls , the company also expects this to be a key part of expanding its drugstore network.
Financials
When we look at Metro's financials , the company appears to be in a good financial position. As of its most recent quarter , the company carries $4.4 billion of debt against $2.4 billion of current assets and $13.8 billion of total assets. With a Debt/Equity ratio of 0.64 and a Net Debt/EBITDA ratio of 2.2x, the company carries modest leverage, which I believe should be well-supported by its free cash flow.
Regarding the company's revenue and EBITDA, Metro has compounded revenues and EBITDA at a 4.0% and 7.2% CAGR, respectively. Compared to the Canadian GDP growth rate of 2.0% over this time period, these numbers look pretty good for a grocer operating in a low growth industry.
One important standout from the chart below is the huge jump in both revenues and EBITDA during the onset of the pandemic. As lockdowns were imposed and people started staying at home, there was a notable shift in consumer behavior towards stockpiling essential items , including food and household supplies.
This sudden change in consumer habits led to a considerable increase in demand for groceries and essential goods, and grocers saw a substantial uptick in sales as people rushed to stock up on items, resulting in higher revenues and earnings for many grocery chains and stores. However, as the situation evolved and stabilized, consumer behavior have gradually returned to normal levels, leading to some fluctuations in grocers' revenues and earnings over time.
Despite this, Metro has still maintained decent margins. Metro's strength during this period was a result of its efficient operations, diversified store network and the company's new focus on enhancing its e-commerce and digital capabilities. In addition, by maintaining supply chains and through prudent inventory management strategies, I believe Metro can likely maintain its current margin profile in the future.
Valuation
Based on the seven equity research analysts with one-year target prices on Metro, the average price target is $77.14, with a high estimate of $83.00 and a low estimate of $73.00. From the average price target, this implies about 11.8% upside.
When looking at the historical average forward EV/EBITDA multiple of about 10.1x, Metro looks to be slightly undervalued at 9.3x, suggesting that the stock may have potential for growth and could be considered attractive based on its current valuation multiples.
When comparing Metro to its peers, the company trades at a discount to its peer group on an EV/EBITDA, EV/EBIT, and P/E basis when looking at the median multiples. Compared to its closest peers like Loblaw and Empire, the company trades a small premium. This can be explained by Metro having more growth opportunity than the other two, given that it only operates in Ontario and Quebec, with room for national expansion. Historically, Metro has also grown faster, so in my view the small premium is justified against its two closest peers.
Risks
Metro's management team describes next year as what will be a 'year of transition', as the company faces significant headwinds as the company invests more capex into improving its supply chain. This will include transitioning current sites into new automated distribution centers, which should make the company more efficient and cut costs in the future. As such, Metro expects adjusted net earnings to be lower by up to 10 cents per share next year.
Another key risk to the company (and one faced by all Canadian grocers) is the growing pushback that Canadian grocers are not doing enough to fight food inflation. In a federal committee hearing in Ottawa earlier this spring , CEOs from Loblaws, Metro, and Empire Foods were scrutinized by parliamentarians on the actions grocers are regarding food inflation across the country. With all three companies having had a second meeting in September, Canadian grocers face risks related to changes in the Competition Act or new tax measures that could threaten their profitability going forward. Key legal developments related to these issues should be watched by investors.
Finally, unlike Safeway with its 'Compliments' brand or Loblaws with its 'No Name' and 'President's Choice' brands, Metro lags its peers in that it does not yet have private label brands. Private label brand often tends to resonate strongly with consumers. In my view, by introducing private label brands and loyalty programs, Metro can better compete with its competitors and strengthen its position in the market, creating a unique selling proposition, offering products exclusive to its stores, and building out a margin advantage over its other products. A well-designed loyalty program would also enable the company to incentivize repeat purchases, gather valuable customer data, and personalize offers, fostering stronger relationships with its clientele.
Conclusion
In summary, Metro operates in a highly competitive market that competes on price. With its recent strategic acquisition of Jean Coutu, the company has positioned itself to expand into the health and wellness sector while leveraging synergies within its existing network. Financially, Metro appears robust with manageable debt levels and consistent growth in revenue and EBITDA, outpacing the Canadian GDP growth rate.
The company's resilience during the pandemic has showcased its operational efficiency and adaptability, resulting in sustained margins and a focus on bolstering its e-commerce capabilities. Despite facing headwinds related to anticipated lower earnings due to increased capital expenditure and potential challenges regarding food inflation and private label brands, Metro maintains growth potential with opportunities for national expansion and differentiation from peers.
This growth potential is key when looking at its valuation. While trading at a discount to its larger peer group and its own historical EV/EBITDA valuation, the company's premium multiple against its closest peers seems justified when we consider its growth prospects and regional positioning.
Despite risks related to regulatory changes and the competitive landscape, I believe that longer term, Metro's investments it's making today and strategic moves will position the company for growth in the future. For investors looking for a safe and growing dividend, along with modest capital appreciation going forward, Metro seems like a strong candidate for investors to consider today.
For further details see:
Metro: Time To Buy This Canadian Grocer