Woolworths Group Ltd (ASX: WOW) is a solid business, but it's not my top pick in the food industry. Instead, I went for the S&P/ASX 200 Index (ASX: XJO) stock Metcash Ltd (ASX: MTS).
I'm not saying that Metcash's food operations are stronger or that it has a better growth outlook than Woolworths. But, the overall Metcash company seems more compelling to me.
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Three pillars
There are three main segments to the Metcash business – food, liquor and hardware.
The food business is best known for supplying over 1,600 independent stores across Australia, with IGA and Foodland supermarkets being two of the main customers.
The ASX 200 stock is the largest supplier of liquor to independently owned liquor retailers. It supplies Cellarbrations, The Bottle-O, IGA Liquor, Porters Liquor, Thirsty Camel, Big Bargain Bottleshop and Duncans.
Metcash's third pillar is hardware. It owns a number of brands and businesses including Mitre 10, Home Timber & Hardware and Total Tools. It supports independent operators under the small format convenience banners Thrifty-Link Hardware and True Value Hardware, as well as a number of unbannered independent operators.
Acquisitions
A few weeks ago, the company announced it had entered into binding agreements for some acquisitions.
One of the businesses it's buying is Superior Food, a leading Australian foodservice distribution business, which it described as a logical extension of the food strategy, partly because it can benefit from and enhance Metcash's core food wholesale and distribution capabilities. Foodservice is described as a large and growing market.
The second acquisition was Bianco Construction Supplies, a construction and industrial supplies business servicing South Australia and the Northern Territory.
Thirdly, it said it was going to buy Alpine Truss, one of the largest frame and truss operators in Australia.
Metcash is expecting to achieve annualised synergies of around $19 million and add to Metcash's margins.
Why I decided to invest in the ASX 200 stock
There are three main things that attracted me to Metcash.
First, the strength and profitability of its hardware business are impressive in my opinion. When interest rates start coming down and the outlook for the economy improves, I think the profitability of the business can grow. The inclusion of Bianco and Alpine Truss is a useful boost for the ASX 200 stock as well.
Second, it has a much lower price/earnings (P/E) ratio than other ASX shares. According to Commsec, Metcash shares are valued at 14 times FY24's estimated earnings and 13 times FY25's estimated earnings. In comparison, Woolworths shares are valued at 23 times FY24's estimated earnings and Wesfarmers Ltd (ASX: WES) – owner of Bunnings – is priced at 30 times FY24's estimated earnings.
I think Metcash is priced attractively for its hardware's growth outlook for the long term. Third, the dividend yield is appealing. Metcash targets a dividend payout ratio of 70% of underlying net profit after tax (NPAT). The FY24 grossed-up dividend yield is projected to be 7.3%.
