$346m up in smoke for Metcash as new tobacco rules hit sales

The ASX-listed group that owns the IGA retail brand in Australia has seen more than $370 million wiped off its market valuation today after Metcash (ASX: MTS) reported a precipitous drop in tobacco sales for the half-year to the end of October, following new regulations that came into force on 1 July.

Metcash, a wholesaler and supplier to independently owned supermarkets including those under the IGA brand, reported a 35.1 per cent drop in tobacco sales to $637.8 million.

This represents a decline in revenue of $345 million for the category, which was subject to a legal transition period throughout the last financial year to phase out certain product and packaging traits. These include appealing flavourings such as menthol and clove that mask tobacco's harshness, and marketing terms like 'smooth' or 'gold' that could falsely suggest products are less harmful than they are.

The new rules have been in place since the start of July, and also require that each pack must be consistent in size while each cigarette must be of the same length and width with unique filters now banned. 

New regulations also require new health warnings and messaging, including directly on cigarette sticks, accompanied by information cards inside packaging to help support people to quit.

Metcash reports that it has "continued to manage the decline well" and is assisting the Independent retail network with its transition away from tobacco sales.

The decline itself is equivalent to around 3.6 per cent of the Metcash group's $9.6 billion in revenue for the six months - a total figure that was up just 0.4 per cent despite a much higher inflation rate of 3.8 per cent in October.

In ex-tobacco terms, group revenue was up 4.5 per cent amidst growth for its food, liquor and hardware divisions, while EBITDA was up 2 per cent to $367.2 million.

Earnings rose for the food business despite further acceleration in the decline in tobacco sales, reduced strategic buying opportunities and the inclusion of one-off integration and strategy costs. However, this was more than offset by decreases for the liquor and hardware divisions.

For liquor the group observed lower wholesale price inflation on strategic buying and higher costs, while for hardware an improvement in sales was offset by margin pressure, mainly in owned trade centres, and an increase in depreciation and amortisation.

The Metcash group also reported increased depreciation and amortisation associated with acquisitions, the new distribution centre in Truganina, Victoria and digital investments.

"The business has delivered solid results in tough trading conditions, supported by disciplined operational performance and the successful execution of our strategy," says group CEO Doug Jones.

"Importantly, we’ve maintained good momentum in our core business, and our independent networks remain healthy and confident despite the challenging conditions.

"Our food business is now highly diversified and very resilient. Food again delivered earnings growth despite the significant and unprecedented decline in the sales of our largest product category, tobacco."

Jones claims that even though the grocery market is at its most competitive in many years, the IGA network is now more competitive than ever.

"The ongoing pleasing performance in Food reflects the success of our core wholesale and logistics functions, improvements made to the IGA network’s value proposition, our investment in Campbells & Convenience underpinning its leading position in supply to the petrol and convenience market, and our expansion in foodservice through the Superior Foods acquisition," he says.

"In Liquor, the benefits of our diversified channel strategy led to sales growth in a more difficult market. Shopper preference for the convenience, quality and value in the independents’ offer underpinned further market share gains in the half.

"In Hardware and Tools, we are seeing early signs of improvement in trade activity which, together with strong operational execution, led to sales growth in both the Hardware and Total Tools businesses, as well as in their retail networks."

MTS shares finished closed trading today down 9.19 per cent at $3.36 - their lowest level since May.