EUR 850.00 For Business Accounts Only

Morningstar | Metro Continues to Face Numerous Industry Headwinds; Shares Overvalued

Metro continued to face numerous industry headwinds, including higher costs from labor, transportation, and tariffs as well as an intense promotional environment, during the third quarter, supporting our no-moat rating. Metro's 13.8% (7% year to date) sales growth and 19.4% (19.6%) gross margins are tracking near our 2018 forecasts for 12% and 19.6% (down 10 basis points). As a result, we do not plan a material change to our CAD 35.50 fair value estimate, which forecasts low-single-digit organic sales growth and relatively flat gross margins over the next five years. We think the shares are overvalued.

The company closed the acquisition of Jean Coutu Group, which has more than 400 drugstores in Quebec, on May 11 and continues to expect $75 million in synergies within three years. We expect these synergies to be largely offset by minimum-wage and transportation costs (which represented around $50 million in incremental expenses versus the prior period) as well as competition. Additionally, Metro continues to invest in e-commerce delivery and click-and-collect infrastructure, which is currently lower profit than its brick-and-mortar operations. The tariff impact presents a near-term uncertainty for the industry, as it is unknown how consumers will react to expected supplier price increases over the coming months. As a result, we remain comfortable estimating stable gross margins averaging 19.6% with operating margins averaging 6.2% the next five years, up about 30 basis points from 2017 (year-to-date operating margins are up around 10 basis points excluding one-time expenses).

According to management, food gross margins were flat while same-store sales grew 2% versus our 2% 2018 estimate. Meanwhile, food basket inflation was 0.5%, slightly above the industry level (unquantified). We view these results as in line and solid, given the continued competition from Walmart, Loblaw, and Amazon.