What the Metcash Downgrade Means for the Australian Stock Market

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If you needed any more evidence of how desperate and focused on yield the Australian stock market is, look no further than Metcash’s announcement on Friday. In an attempt to revive its struggling food distribution and retailing business, Metcash [ASX:MTS] announced that it would invest nearly $700 million over the next five years.

To help fund the investment program, the company said it would cut its dividend payout ratio from 90% to 60% – which represents a sizeable dividend reduction. Hearing ‘dividend’ and ‘cut’ in the same sentence saw the market dump Metcash shares by nearly 10% on the day.

There were plenty of reasons to be wary of investing in Metcash before Friday’s announcement. Being caught in a competitive battle with Coles and Woolies being just one of them. But here’s the weird thing about the market right now…

Metcash was distributing nearly all of its profits in dividends in an industry where its two largest rivals are investing heavily in growth. And it could keep this up only to the detriment of its competitive positioning and earnings growth. Yet the market continued to buy the stock for the ‘yield’.

But now that Metcash has faced reality and announced plans for growth, the market drops it like a hot potato. In other words, the market puts a higher price on a business that distributes nearly all its earnings and thus doesn’t grow its assets via reinvestment, and a lower price on a business that plans to generate long term growth through an extensive investment program. That’s not terribly rational.

Granted, no one knows whether the plans will work or whether the investment will generate a decent return, but the ‘buy for yield’ logic befits a market that is very shortsighted and unquestioning right now.

Regards,

Greg Canavan+
for The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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3 Comments on "What the Metcash Downgrade Means for the Australian Stock Market"

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Ross
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Nothing exceptional ….

“I can’t stand up for falling down”

is the way of the western world.

In the beginning there was the reserve banker…. The closer you are to them the longer the ride (bonds and bank dividends) until the cancer spreads to each and every asset and it goes pop.

Ray
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“the market puts a higher price on a business that distributes nearly all its earnings and thus doesn’t grow its assets via reinvestment, and a lower price on a business that plans to generate long term growth through an extensive investment program. That’s not terribly rational.”

Absolutely rational if you consider how over investment can lead to capital generating very low returns in future.

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