Metro Sees Some Gross Margin Pressure With More To Come

Metro Inc. (OTCPK:MTRAF, TSX:MRU:CA) has been staying ahead of inflation and producing decent growth of 14% in EPS. The multiple is low at around 12x on a forward basis, and it produces the sort of earnings yield that investors want as rates come up. However, there are continued inflation pressures on the horizon, and negative latent effects on gross margin have built up. Moreover, the demand side is getting more and more competitive. Overall, Metro Inc. is a fairly valued company but not an idea with any special edge.

Discussing Q1 2023

The Q1 results have come out and they're pretty good. Food sales were up 7.5% in retail channels, pharmacy sales were up 7.7% driven by non-prescription products up 10.2% (prescription drugs up 6.5%). Cosmetics and beauty products drove things in the pharmaceutical business, and these are typically higher margin segments that should have produced positive mix effects, but inflation affected the ability to grow gross margins, which shrank from 19.9% to 19.6%. Gross profit still grew over 8% because the 8.2% sales growth outpaced the COGS growth, but inflationary effects are visible. Operating remained quite stable, growing only 4%.

Upcoming Pressures

Firstly, the company is expecting further growth in OPEX, where it was 4.5% already. Labor is one issue, where minimum wages in Quebec are up 7% to give an idea, and labor availability still remains tight causing more concerns around how labor costs will rise for the company. Apparently Metro Inc., with its somewhat considerable bargaining power, did a blackout of allowing price increases from its vendors since November that has mitigated the situation so far. That means that over the last few months the next wave of price increases are building up to be released soon, coming from vendors in OPEX but also in inventory, which is one of the areas where inflation is not really very under control, especially in food. So, there's also going to be another wave of price increases coming from vendors in the COGS line.

On the demand side, people are really stretching their dollars, and promotional services in place for customers are being fully utilized. The typical basket for Metro customers is becoming cheaper, and this is a pressure on ARPC, especially with retailers watching each other and drawing red lines for themselves past which prices cannot rise.

Still, things are going decently well in pharma. While some businesses are struggling with COVID-19 reversals, discretionary COVID-19 related spending on things like tests, also being pushed by an oncoming flu season, continue to help demand. Cosmetics are showing some resilience, too. But the issue around gross margins and margins in general remains even for these segments.

Metro Inc.'s forward P/E is around 12x, which is quite low and offers a decent earnings yield ahead of the increasingly higher rates (the dividend of 2.2%, though, is a little lacking). But because there are mounting pressures, and because there are still unbelievable bargains available on global markets, Metro Inc. stock is not cheap enough to really compel a buy. If the direction were better, it might be a better consideration, but as it is, Metro Inc. is not cheap enough.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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