License article

Bombshell shows retail war is hell

Metcash boss Andrew Reitzer has a reputation for being a shrewd and tough operator in the supermarket business but his announcement yesterday of $133 million of unexpected abnormal charges to the company's profit was a major test of his management's credibility.

The biggest eyebrow raiser was a $75 million to $90 million impairment charge against its investment in, and loans to, a couple of its joint-venture supermarket groups in Queensland that were experiencing trouble and were in ''work out'' mode.

The issue is that there had been no hint to the market that these two supermarket groups, Cornetts and Walters, were in such dire trouble.

This, in turn, begged the question of whether Metcash was sufficiently across the predicament faced by its joint-venture partners. If it was, why had it not conveyed this to the market previously?

Reitzer said Metcash was aware of the troubles being experienced by Cornetts and Walters and had been attempting to work with both to sort out the issues.

The Australian Securities and Investments Commission has been demonstrating a tough stance on the timing of market disclosure of ticking bombs.


Investors looks very unfavourably on earnings surprises and Metcash was no exception.

But in the end, the price deflation, rapid expansion and natural disasters had placed too much pressure on the Queensland businesses, which are now having to be restructured. Eight will be closed, 22 will be sold to other IGA retailers and 26 will be retained.

Metcash admits it does not have management control of its joint-venture retail partners and when mistakes are made - like aggressive expansion or, in one case, poor succession planning issues - it is not in a position to control strategy.

This raises the question of whether there are other Metcash joint-venture partners that could be vulnerable.

While Reitzer insisted the others were travelling well, the spectre of a repeat performance weighs heavily with investors. The market response was to mark Metcash shares down by more than 4 per cent.

The other message that came from yesterday's strategy announcement was that Metcash had embarked on a series of cost-cutting initiatives, including the closure of 15 regional Cash & Carry branches, which serve myriad regional convenience stores, and the removal of 8.5 per cent of the group's workforce - 478 positions.

Taking these costs out of the organisation is a positive element (from a commercial perspective) but it reveals one of the tragic consequences of the ferocious supermarket war between Coles and Woolworths.

The corner shop convenience stores are under severe pressure because consumers are abandoning higher-priced small shops that cannot match the discounted prices offered on basics, such as bread and milk, in favour of supermarkets.

This at least explains why the major chains and Metcash are building or holding market share.

But the discounting (which in retail parlance is called price deflation) is playing havoc with everyone's margins.

Metcash said price deflation was running at almost 1 per cent on dry groceries but at 17 to 27 per cent on fresh food.

The price cutting on fresh food is generally the result of an oversupply from growers that have had a particularly good year - especially when compared with last season.

But on dry goods, the price deflation is a direct response to the savage price-cutting war between the two chains that dominate this market.

Metcash is not in a position to muscle suppliers in the same way as Woolworths and Coles but Reitzer says grocery manufacturers offer Metcash the same wholesale prices in order to keep a third viable player in the market.

Last year, Reitzer predicted price deflation would ease but now he has changed his tune. About half of goods sold are on promotion - that is, discounted. The newly conditioned consumer is looking for bargains and is disinclined to buy ''retail''.

Despite the headwinds of price deflation, margin pressure and the abandonment by customers of non-bannered retail stores (which use Metcash for wholesale supply) the company insists its previous profit guidance stands.

But there remains some scepticism that underlying profit projections will hold.

The upfront and costly restructuring (store closures and sackings) will result in a $25 million to $30 million improvement in operation income in the 2013 financial year and a further $10 million to $15 million the following year.

The acquisition of Franklins remains a work in progress. But the sale of the retail supermarkets is running a little behind previous guidance - with 15 of these stores to be exited or sold outside the IGA network. Previously, six to 10 had been earmarked for this fate.

Reitzer insists he can meet previous guidance because the strategy is sound. But retail supermarket conditions are clearly challenged and Metcash, to some extent, is at the mercy of how its retail customers manage this difficult market.