Morningstar | Metro Executing Well Through Ongoing Headwinds, but Shares Are Overvalued
Metro reported solid 3.5% first-quarter sales growth (excluding the Jean Coutu acquisition that closed May 2018), tracking near the 3% organic revenue lift we model for 2019 (fiscal year ending September). Meanwhile, competition, transportation, wage, Jean Coutu mix, and generic drug regulation remain near-term and long-term headwinds, with gross margins dropping 10 basis points to 19.4% (matching our expectation for the current fiscal year) in the quarter. As a result, we don't plan any material change to our CAD 37 valuation that incorporates 2.2% average annual revenue growth over the next 10 years and gross margins of 19.2% in 2028 versus the 19.7% reported in 2018. Trading above 16 times fiscal 2019 earnings per share, we see Metro shares as overvalued.We believe that industry food basket inflation of 1.8% (higher than the 0.8% and 0.5% lift witnessed in the prior two quarters) is manageable for Metro, which is supported by the company's 3.2% food same-store sales growth. That said, the competitive environment remains intense, so we don't expect much change to our 2.5% consolidated same-store sale forecast for the year (which also includes the pharmacy business that saw just a 1.5% lift in same-store sales in the quarter).
We continue to expect the Jean Coutu drugstore business (around 20% of total revenue) to grow revenue low single digits on average annually over the long term with expected synergies offsetting its lower margin operations. Jean Coutu's annualized revenue of $3 billion is directly in line with our forecast for the year. Meanwhile, we estimate that the segment presented around a 40-basis-point headwind to consolidated gross margins. Still, we believe that Metro is on track to achieve its goal of $75 million in synergies (about 3% of this year's total operating expenses) from the Jean Coutu business by the middle of 2021, which is supported by the $10.7 million in synergies achieved during the quarter (now annualizing at $28 million).
Metro is a food retailer and distributor that operates supermarkets, discount stores and drugstores in Canada. Co. operated 343 supermarkets under the Metro and Metro Plus banners, nine stores under the Adonis banner, and 213 discount stores under the Super C and Food Basics banners. Co. also acts as a distributor for medium-surface food stores and convenience stores. Co. also acts as franchisor and distributor for 181 franchised Brunet Plus, Brunet, Brunet Clinique, and Clini Plus drugstores, owned by independent pharmacists; and operated 73 drugstores under the Metro Pharmacy and Drug Basics banners. Co. also supplies non-franchised drugstores and various health centres.
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