Solid Metcash has the goods
Sydney Morning Herald
Saturday March 26, 2011
During the credit bubble, many professional investors "reached for yield", taking extraordinary risks for an extra 1 per cent or 2 per cent return. That's how they ended up with portfolios of mortgage-backed securities - AAA rated of course - stuffed with toxic loans paying not much above deposit rates.Corporates got in on the act, too. Several listed property trusts almost collapsed under the weight of debt-fuelled offshore acquisitions. All were supposed to increase distributions to yield-starved investors."Sophisticated", risky strategies like these thrive when debt is cheap and plentiful. But as author and economist John K. Galbraith said in A Short History of Financial Euphoria: "The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version."Fool me onceThe relatively low returns on the US junk bond market suggest the latest wheel is as wonky as the last. "Ironically," warned US super-investor Seth Klarman, "the first thing to rebound from the 2008 collapse isn't jobs or economic activity but speculation."Ben Bernanke and his magic money-printing machine have created an intoxicating mix of low interest rates and liquidity. The result is another bull market in risk, which is why The Intelligent Investor suggests you seek high- quality businesses and increase your cash holdings. Food wholesaler and retailer Metcash is a good proxy for the sort of stock that we're recommending at present.Sporting a relatively safe and attractive 6.6 per cent yield, it won't be heavily affected by the disaster in Japan, with much to commend it.Hidden in plain sightThe resurrection of Metcash from the ashes of ambitious retailer Davids, which itself almost collapsed under a weight of debt in 1997, echoes that of competitor Woolies in the 1980s. It's now a great success story, boasting total shareholder returns (capital gains plus dividends) of 15.9 per cent per year since 2001, out-doing the still-impressive 12.2 per cent delivered by Woolworths in the same period.Metcash has a 20 per cent share of the national grocery market but doesn't own a store. It licenses the IGA brand to private operators and then supplies them with more than 60 per cent of their stock.The IGA network includes 2500 independent supermarkets, giving Metcash bulk buying power over suppliers. These savings allow operators to drop shelf prices and compete with Coles and Woolies.Metcash chief executive Andrew Reitzer has said profit would double if it competed on a level playing field with Coles and Woolies.Good things come in small packagesBut whereas its larger competitors tend toward big box retailing, IGA targets a more local experience, squeezing into smaller, more convenient locations where shoppers are prepared to pay higher prices. They may spend less, but this is the company's major competitive advantage and helps it avoid direct competition with the majors.The business model is different, too. Extending the network doesn't require huge licks of capital. And the narrower product range means it has to deal with fewer suppliers, creating storage and distribution efficiencies.What's the catch?Metcash boasts a strong market position, an attractive customer proposition, shrewd and shareholder-friendly management and high returns on capital. So why is it trading at a knockdown price?Analysts love growth stories - they're much easier to sell to clients - and right now Coles is getting all the attention.Metcash's recent growth spurt is (rightly) viewed as unsustainable and this is a simple, predictable business with all the sex appeal of a Warren Buffett swimsuit calendar.But given the fat 6.6 per cent fully franked forecast dividend yield, today's investor doesn't need much growth to do well. There is no "reaching for yield" in Metcash - it's a solid, defensive business that should do well if the bull market in risk topples.Then, when the wheel turns and all that was old becomes new again, investors may come to appreciate a stock as dull and predictable and profitable as Metcash.Of course, by then it may well be too late to buy in at an attractive price. But that's how the market works. And Galbraith knew it all those years ago.
© 2011 Sydney Morning Herald
