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Edited Transcript of MTS.AX earnings conference call or presentation 4-Dec-19 11:00pm GMT

Half Year 2020 Metcash Ltd Earnings Call

Silverwater, New South Wales Jan 24, 2020 (Thomson StreetEvents) -- Edited Transcript of Metcash Ltd earnings conference call or presentation Wednesday, December 4, 2019 at 11:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brad Soller

Metcash Limited - Group CFO

* Christopher William Baddock

Metcash Limited - CEO of Australian Liquor Marketers

* Jeffery K. Adams

Metcash Limited - Group CEO & Executive Director

* Mark Laidlaw

Metcash Limited - CEO of Independent Hardware Group

* Scott Marshall

Metcash Limited - CEO of Food

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Conference Call Participants

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* Andrew J. McLennan

Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst

* Ben Gilbert

UBS Investment Bank, Research Division - Executive Director and Analyst

* Bryan Raymond

Citigroup Inc, Research Division - VP & Analyst

* Johannes Faul

Morningstar Inc., Research Division - Equity Analyst

* Keegan Booysen

Jefferies LLC, Research Division - Equity Associate

* Phillip Kimber

Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer

* Richard Barwick

CLSA Limited, Research Division - Research Analyst

* Shaun Robert Cousins

JP Morgan Chase & Co, Research Division - Senior Analyst

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Presentation

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [1]

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Okay. Good morning and welcome to the Metcash First Half Results for Financial Year '20. As most of you have been joining us online for these results, we thought we would save a bit of money this year. So this will be one of our cost-savings initiatives and not hire a venue today and do this online.

We'll follow our normal format this morning. I'll talk you through the group and the individual business results. I'll then hand over to Brad to cover the financials, and then I'll come back to cover the outlook statement before moving to the Q&A.

Before we start, just to let you know who we have in the room today. So besides myself and Brad, we have Scott Marshall, the CEO of our Food business; and Mark Laidlaw, the CEO of our Hardware business; and Chris Baddock, who's our -- I guess we can still call you new CEO of our Liquor business. And the business CEOs will be around and they'll help us at the Q&A at the end.

So just turning over now to our purpose and vision and values. Just as a reminder, our purpose is about championing successful independence, and this, along with our vision and values, are the focus of everything that we do at Metcash. So no changes there.

Just moving on now to the group overview. So we've highlighted at the start a few of the key points in our results, and I'll cover these in more detail as we go through the presentation. But they include total Food pillar sales, including charge-through, increased 1.2%, with Supermarkets sales -- wholesale sales, ex tobacco, being positive for the first time since financial year '12, so a real accomplishment from the Food team.

Liquors delivered its sixth consecutive year of earnings growth. And our Trade-focused Hardware pillar continued to perform well despite difficult trading conditions. And our MFuture programs are progressing across the pillars.

Our half year statutory results reflect the adoption of the new accounting standard AASB 16. However, we have tried to show the pre and post AASB 16 result for comparative purposes to last year, where appropriate. It's suffice to say that adopting AASB 16 has been a very onerous task, and the team has worked hard to get this done. So today you'll hear a lot of pre and post as we go through these results, and I know Brad will help you try to understand this better later in the presentation.

So just moving down the page now. Group sales, including charge-through sales, increased 0.5% to $7.2 billion, with sales growth in the Food and Liquor pillars partly offset by a decline in the Hardware sales, which is mainly in Trade. Following our goodwill impairment announcement of Tuesday related to the loss of the 7-Eleven contract next year, reported loss after tax of $151.6 million.

Underlying profit after tax on a pre AASB 16 basis was $95.7 million versus the first half of last year of $100.2 million (sic) [$100.3 million]. Year-over-year has been impacted by the contribution from the onerous lease provisions reduced by about $10 million in the first half of the year and then ceasing to supply Drakes in SA for about 1 month.

So continuing to the group overview on the next page. Group underlying EBIT pre AASB 16 declined by $8.4 million to $149.7 million. Food EBIT decreased by $7.8 million to $85.2 million. This is because of the lower onerous lease provision releases, as I said, and about 1 month supply from Drakes from the 30th of September. Liquor EBIT increased by $0.5 million to $29.6 million, and that's a flow-through of the higher sales in Liquor. And Hardware EBIT decreased by $0.5 million to $37.3 million, impacted by the lower Trade sales.

Underlying EPS pre AASB 16 declined by 0.9% to $0.105. And then Brad will just talk you through in more detail later on the balance sheet and also cash flows, but just we have maintained a strong balance sheet. And the Board's approved an interim dividend of $0.06 per share fully franked.

The next slide is a roll-up of the group results, which I'm not planning to go through in details. I'll cover each of the businesses. However, you can see on the right of this slide the breakdown of the percentage of the group sales and EBIT and how Food remains a key part of our business.

Turning now to Food, looking first at sales. You can see from the chart on the bottom right, the journey we've been on and the steady progress and improvement the business -- the Supermarket business has been making. And as I mentioned at the start, getting to positive growth in the first half, excluding the Drakes impact, for the first time since financial year '12; a significant accomplishment from the Supermarket team. And from the time that I joined about 2.5 years ago, many people told me they didn't believe we could get Food sales back into positive growth.

Moving down the slide now. So total Food sales, including charge-through increased 1.2% to $4.4 billion. And Supermarkets total sales, including charge-through, increased 0.8% to $3.6 billion. That would be plus 1.2% if you excluded the Drakes impact. I talked about the wholesale sales ex tobacco improving to minus 0.3% from 1.9% (sic) [plus 0.3% to minus 1.9%] last year. And again, that's positive, if you exclude the impact from Drakes.

Sales improvements are being driven by the successful execution of our growth initiatives and a reduction in price deflation to about 0.1%, and that comes despite us continuing to invest into price to make our retailers more competitive.

Wholesale sales trajectory has improved in all of the states, another very positive sign there. Queensland was the strongest performing state. We've seen sales growth in SA, ex Drakes impact, with Foodland stores performing well, and another very positive sign, and a significant improvement in WA sales trajectory with sales now broadly flat with the first half of last year, after many years of decline.

IGA retail like-for-like sales back into positive growth. Net IGA store closures of 10. However, we do expect that to turn around in the second half of the year, but we are a bit dependent on the developers to get the projects finished there.

Another very positive sign, teamwork score improving now, up to 74% from 72% of last year.

And in convenience, total sales increased 2.8%, and that's mainly driven from higher tobacco sales.

Looking now at Food EBIT. Reported EBIT of $88.4 million includes a positive AASB 16 adjustment of $3.2 million. EBIT on a pre AASB 16 basis declined $7.8 million, and it's from the impacts that I discussed previously, which is about $10 million reduction in the onerous lease provisions from last year and 1 month of supply to Drakes, which we've called out would have been about $1.5 million.

This has been partially offset by improved wholesale sales ex tobacco, cost-savings initiatives, improved earnings from our joint ventures and corporate stores, and a positive contribution from our Convenience business.

Looking now at the Food MFuture initiatives. Across the top of the page, we've listed the key MFuture initiatives for Food, and below them, a short update on the progress of each. Working across these and just picking up some key points, starting with brand clarity. We've now called out that's a 3-year -- going to be a 3-year rebranding program. And as we said at our March Investor Day, it's about getting the right brand, the right offer and the right location. We've had very good engagement from the retailers, and we are working closely with the retail working group and also the NRC on developing this, and they've been making some very good progress. We've already launched out the small-format trials. So that's The Fresh Pantry stores, which I'll talk about in a minute. And now we've completed that branding work on the large-format store, and that first trial store is scheduled to open in the second half of the financial year. The big focus now for the working group is on defining that core IGA brand, with good progress they've been making on that.

On Diamond Store Accelerator, a further 45 stores completed the program in the first half of the year compared to 9 last year. So the acceleration that we've talked about there is taking place. That brings the total stores through the program to 450 and another very positive sign. So the average sales growth from the DSA is now up to 15%. And we've called out before, that was about 10% before, so a good improvement in the result from DSAs.

Our trials on our small format offer are continuing, so we now have 3 of those stores open. We mentioned Bondi, when we did our full year results, had opened. We've now opened in Chatswood and also in North Sydney. And we continue to get good results out of those stores and really helps us in our learnings of how to work better with our retailers. We're expecting that trial to continue through the end of this financial year, and then we'll be evaluating the trials at that point for either further trial or for rollout.

We continue to grow our Community Co range. So we have a further 70 products that have been added to the range, which brings it to about 350 now. And Community Co sales have increased about 50% over the first half of financial year '19.

And finally, in systems and logistics, again, good progress there. So automated charge-through, which we talked about for a while, is now in -- is up and running and is being rolled out. Our loyalty program and IGA Rewards, which we trialed in WA, is now being rolled out to all of the states and going well. We've successfully integrated the Supermarkets and Convenience logistics network, which has helped us on our cost savings. And the construction of our new DC in SA is progressing well. And then the other point on there, which we're very pleased about, that we've worked closely with Aussie Post on becoming one of their preferred partners for their click-and-return locations, which some of you may know across the world is actually doing quite well of driving new customers into the retail stores.

Moving on now to Liquor. In Liquor, total sales, including charge-through, increased 1.7% to $1.8 billion. The premiumization trend that we've been talking about for a while now has continued driving value growth. The like-for-like IBA sales are once again positive at 1.7%. And we're seeing growth in our contract customers, some new customers, and in our on-premise business. The sales through the IBA bannered network is about in line with last year at 54% of Liquor sales. The rollout of our Porters Liquor brands is starting to gain some momentum, and I'll talk a little bit about that. And we're expecting WA Container Deposit Scheme to commence in June 2020.

Looking at Liquor EBIT now. Reported EBIT of $30.7 million includes a positive AASB 16 adjustment of $1.1 million. EBIT on a pre AASB 16 basis increased $0.5 million to (sic) [or] 1.7% to $29.6 million, and EBIT margins have been maintained at 1.7%. We did ask Chris if he likes 1.7% because there's a lot of 1.7s in his numbers.

Next slide has the Liquor MFuture initiatives. Again, the key initiatives are listed across the top of the slide, starting with store investment, and that's really our "Best Store in Town" initiatives, which you would have heard from us before. So in the half, we've completed 36 refreshed stores, which brings that to about 370; and we've upgraded a further 29 cold rooms, which brings that up to about 640 now, so good progress there.

Our Porters premium liquor brand is starting to roll out now. And that's -- number of stores has increased in that to about 25 and we've -- mostly in New South Wales, but you can see there, we've listed some of the new store openings and there are just plans now from Chris and the team to expand that into WA and Tasmania in the second half of the financial year, and we are expecting to add about 10 more stores in the second half.

Good progress on our Private and Exclusive Labels, which I know, again, given Chris' background, is a priority from him. We've added some additional SKUs in the ranges. And we are seeing Private Label sales in our wine category rising. In fact, it was about 20% in the first half of the year.

In our on-premise initiative, which we called out at the Strategy Day, again, another one of our key initiatives, we've launched ALM Agora, which is our online marketplace that connects the on-premise venues with the suppliers, and we're seeing very good support, both from the customers and from the suppliers for Agora. Early days, but going well. And you can see there that we've called out we're adding up -- we're adding some new customers. And the sales are up in on-premise about 10%, so starting to gain some good momentum there.

And finally, in digital, which, again, I know, is one of Chris' priorities coming in and he's looking at ways that we can accelerate the e-commerce platform there, which we see as a big opportunity for us to grow sales, and also the establishment of a loyalty program across the network.

So moving on now to Hardware. So total sales, including charge-through, decreased 4.2% to $1.04 billion, mainly reflecting the impact of the slowdown in construction on Trade sales. If you exclude the loss of the large HTH customer in Queensland, which we called out before at the full year results, the net decrease would be 2.5%, which I have to say, I believe is a pretty good result in a tough market.

Like-for-like sales in the IHG banner group decreased 3.2%, again, reflecting the market conditions.

Our Trade sales now account for about 64% of total sales. That was 65% last year. And we are seeing an improvement in DIY sales, supported by the acceleration of the Sapphire program, core range and the expansion of the digital platform.

Looking now at Hardware EBIT on the next slide. So reported EBIT of $38.9 million includes a positive AASB 16 adjustment of $1.6 million. On a pre AASB 16 basis, EBIT decreased by $0.5 million to $37.3 million, impacted by the decline in trade sales, and that's been partially offset by Mark and the team by improved DIY sales. Very good work, I would say, from the team on cost efficiencies and full -- and some synergy benefits still flowing through on the HTH acquisition.

HTH (sic) [IHG] wholesale margins were at 2.9%. The total IHG EBIT margins have increased by 10 basis points to 3.6%, which largely reflects the portion of retail sales that are coming through on our JV and our company stores.

And finally, to look at the Hardware MFuture work. So Sapphire remains one of our key, obviously, MFuture initiatives in Hardware, the upgrades there. Total stores through the program and in progress has increased to 75. So we are still targeting 200 stores to be upgraded by 2022. And we still continue to see strong retail sales growth in those stores that we've refreshed of greater than 15%.

In build trade, we've acquired 2 frame and truss plants through the acquisition of Keith Timber in SA. And frame and truss offers are now available in all of our states. And we've called out before, that was one of our key things in Whole of House strategy. We've increased the number of supply and install alliances to 15, and those alliances are now in place with key players across all of the stages of a house build. And we continue to roll out our Hardings plumbing offer through the rest of the IHG network.

In grow retail network, our retail and joint venture company-owned stores has now increased to 102. So in the first half of last year that was 92. And we've got 37 company-owned stores and 65 JV stores. We've listed there for you the additions that have been made in the half. And our company-owned and JV stores now represent about 15% of our total stores, but 40% of our total IHG sales, so quite significant for the network.

Another key initiative for Mark and the team is in digital and trade technology, which we talked about to you guys, and online sales are up about 50% in the half versus last year. We've significantly increased the number of SKUs that are available in this over that time now. So we're up to about 11,300 SKUs that are available online versus about 3,000 this time last year. And another big accomplishment and milestone where we've gone over about 1 million members in our loyalty program in Mitre 10.

We're getting very good uptake and strong retailer support for online initiatives in Trade, and that includes things we've talked about before, which is Truck Tracker, Trade Online and Trade Plus. And we've expanded the number of our trial stores for Connected Home up to about 15 stores now.

And finally, on cost efficiencies. I'd say Mark and his team are very focused on driving cost out, continuing to focus on that given the tough market conditions that are out there in the trade right now. And a great effort from the team in the first half of the year.

So with that, I'll now hand over to Brad, and he'll take you through the financials.

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Brad Soller, Metcash Limited - Group CFO [2]

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So thank you, Jeff, and good morning, everybody.

So as you would have seen when Jeff went through the pillar results, due to the implementation of the new accounting standard, AASB 16, this year's numbers are not at all easily comparable to last year when you try and compare them on a stat reporting basis. And also, given our April year, we are one of the earlier companies to report under this new accounting standard.

While the overall impact on our earnings is not material, there were significant changes when items -- where items are reported in both the P&L account and the cash flow statement and a huge grossing up of our balance sheet.

In our case, the position is made more complicated by the significant number of back-to-back leases with retailers in our portfolio. And in our presenting our results, as Jeff said, we've tried to make it easier for you guys by also reporting our numbers on a pre AASB 16 basis. We did this to enable the period-on-period comparisons to be made, and those are the numbers that Jeff talked you through when he was reviewing the performances of our businesses.

As our statutory accounts for the half year [have been] prepared on a post AASB 16 basis, let me take a little bit of time to give you a very high level overview how AASB 16 has impacted us in our reported results.

So we adopted the leasing standard with effect from the beginning of the current financial year. And unlike prior changes to accounting standards, we are not required to, and we have not, restated the prior year comparators.

So what has the standard done to our financial statements? So let's start, first of all, with the balance sheet. In effect, all that has actually happened on the balance sheet is that we have now grossed up the balance sheet, recognizing assets to the value of about $937 million and offsetting liabilities for the amount of $939 million. There is a small difference of about $2 million, and that difference relates to how we treat some of those back-to-back leases.

The grossed up liability represents the liability both from the leases we occupy and the subleases to our retailers. And the assets itself is split between the premises we occupy, that's valued at $601 million, and the rent due to us on the subleases, which is recorded at $335 million. In determining our debt ratio in the later slides, we have not included the lease liability of $940 million.

So if that's complicated, we'll then actually move on to the impact on the P&L account. So with respect to the P&L account, the key changes are: firstly, we removed the net rental expense of $60 million, and this has now been replaced with the depreciation charge of $49 million and a finance charge of $13 million. So adjusting for all these, the outcome in the first half of the financial year was we see EBIT going up by $6 million, we see EBITDA going up by $55 million and profit after tax is down by just over $5 million.

Now we need to -- if you look at towards the full year, we gave you previously some guidance as to what the full year impact of AASB 16 was going to be, and we said when we did our initial work, that we expect it to be around $15 million for FY '20. We still expect FY '20 results to be adjusted by that amount of around about $15 million.

So if that doesn't distort our numbers enough and you'd wonder how you could ever get changes to cash flow, there is -- while there is no change to the net cash flow, the standard also requires the cash flows to be reported in different lines. So those changes have flowed through. And as I said, in order to make your life easier, we'll actually continue to talk to the FY '20 numbers in our full year results presentation on a pre AASB 16 basis, and that will enable you guys to make more meaningful comparisons. And then once we have an audited set of accounts for FY '20, when we go into FY '21, we'll start talking to our results on a post AASB 16 basis.

Now I'm sure that was riveting, but those of you who want to actually go through it in more detail, there is information provided in Appendix B and the notes to our half year accounts.

Let's move on to the next slide. As you are all no doubt aware, we received notification from 7-Eleven that they intended to terminate their supply agreement with us, which expires next year. Just to remind you as to the impact of this notification. We will continue to supply 7-Eleven until the contract expires, which is in August 2020, and we do remain in discussions with them about supplying WA and some smaller categories. The expected loss of revenue will be around about $800 million, and as we said, a significant proportion of this is lower margin tobacco sales.

Given the significance of the loss of sales volumes, we believe it is important to guide you as to the most likely impact of the loss of these sales on our earnings, and we believe the loss of 7-Eleven volumes will negatively impact EBIT, after adjusting for variable cost savings and other cost mitigants and allowing for stranded fixed costs by around $15 million on an annualized basis.

This has had a knock-on impact on the carrying value of our goodwill. The goodwill accounting standard is very prescriptive and does not allow us to adjust for the loss of earnings or expected cost savings that will be made following the loss of volumes. As an example, the impairment calculation assumes no reduction in variable labor costs as a result of these lower volumes.

We have, therefore, recognized an impairment of $237.4 million post-tax in the half year accounts related to goodwill and other assets. Of this, $225.6 million of the write-down relates to the goodwill and the balance to assets that were predominantly used to service the 7-Eleven account. And so that this does not distort the underlying earnings, this has been separately disclosed on the face of the P&L account. The impairment is noncash in nature, has no impact on our debt facilities or compliance with our bank covenants.

Turning now to profit and loss account. As both Jeff and I have said, reviewing the year-on-year performance on the statutory reporting basis is difficult given the changes as a result of AASB 16. While we have actually shown the results on a post AASB 16 basis, I will talk to the shaded numbers on the slide, which are all pre AASB 16.

Jeff has already spoken to the performance of the pillars, which is the results that go down to the group EBIT line of $149.7 million. $149.7 million.

Calling out the other key lines in the P&L account, as you can see, depreciation and amortization on a pre AASB 16 basis is broadly in line with last year at $29.6 million. And as you will see in our cash flow slide, this is also broadly in line with the capital expenditure for the half. Obviously, on a post AASB 16 basis, it is much higher.

Net finance costs of $13.8 million are $0.7 million lower than last year, the lower interest rates in the period more than offsetting the higher average debt levels. And as with depreciation, this line will change significantly as a result of AASB 16.

The group effective tax rate of 29.2% is in line with prior periods, and you should continue to expect our effective tax rate to be broadly in line with the corporate tax rate.

In line with our guidance to the market, we have separately disclosed MFuture implementation costs. These costs are limited to cost-saving initiatives and the cost of moving to the new SA DC. The cost amounted to $4.8 million post tax, which is broadly in line with what was spent on Working Smarter last year.

On a statutory reporting basis, we reported a loss after tax of $151.6 million, which includes the goodwill and asset -- other asset write-downs of $237.4 million.

As you can see, the positive -- you can see the positive impact of last year's share buyback on the EPS number, which is 0.9% lower than last year, whereas the decline in underlying earnings was 4.6%.

Moving now to the cash flows. Once again, we've looked at these on a pre AASB 16 basis. Net cash inflow from operating activities was $59.3 million in the half, and this represents a cash conversion ratio of around 47%. This is significantly lower than the prior periods, and our long-term cash conversion target of 90%. You should recall that over the last 3 years, our average cash conversion ratio has been over 100% as we drove the business extremely hard to reduce working capital investment.

The lower cash conversion ratio -- conversion in the half has been impacted by the timing of payments, however, more significantly by investment in working capital across all pillars, most notably the Food pillar. We do not expect an improvement in working -- in the working capital position in the second half of the financial year and believe this investment in working capital is required to be maintained to grow the business. And given the low cost of debt, we have taken the opportunity to improve service levels.

Capital expenditure in the half at $30.5 million is up 6% on the prior period as we invest in growth initiatives. A more significant increase in capital expenditure related to the MFuture program is expected in the second half of the year and next financial year.

During the period, we spent $23.2 million acquiring businesses, which include 3 acquisitions in the Hardware pillar, including the frame and truss operations Jeff spoke about, and purchasing the balance of shares in G Gay, increasing our ownership from 49% to 100%. These acquisitions added a further 9 stores to the network.

There was a net inflow from the sale of business and net loan movements of $2.5 million, with more loans being repaid [than advanced] in the period.

In Food, to date, the retailers continue to finance the DSA on these stores themselves without assistance from Metcash. And as a result of this and after including dividends paid in the period of $63.6 million, net debt increased by $60 million versus FY '19. This is showed on the balance sheet on the following slide.

The October balance sheet is post AASB 16, and unlike the P&L and cash flow, we have not adjusted the prior year comparatives for the impact of the new standard.

Key points to note on the balance sheet are, firstly, as called out in the cash flow, we saw a $53 million increase in working capital from the year-end position and a $63 million increase versus prior year. And the intangible asset balance has declined following the adjustment to the Food goodwill. To assist with the comparison, we have separated lease balances on the face of the balance sheet, including provisions which relate to long-term leases. The balance sheet reflects the net debt position of $95.3 million versus $35.5 million at the end of FY '19.

Moving to borrowings in slightly more detail. Even on this slide, the new standard has had an impact, albeit a small impact. For those of you who have good memories, our reported debt last year was $43 million, and this has been adjusted down to $35.5 million as some finance leases have now been reallocated. Debt in the half increased from $35.5 million to $95.3 million. And as I advised you before, our debt position is in the low point in October and April, reflecting our seasonal cycle, such that our average borrowings are higher than what will be reflected in the balance sheet, with average net borrowings in the half being circa $368 million.

The debt ratios are shown on the right-hand side, and that reflects our balance sheet capacity. And as shown on the graph on the left-hand side there, the group has no debt maturities in FY '20 and the maturity profile thereafter is well balanced.

Moving to dividends. The Board has approved an interim dividend in line with our current payout guidelines of 60% of underlying earnings. This results in an interim dividend of $0.06, which will be fully franked. Our shares will go ex-dividend on 17th of December, and the dividend will be paid on the 23rd of January.

I'll now hand back to Jeff to go through the outlook statement, and then we'll take your questions.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [3]

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Okay. Thanks, Brad. Before I go through the outlook statement, I will let Chris take just a couple of minutes to introduce himself to you and also just to give you a few of his initial sort of thoughts. Chris?

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Christopher William Baddock, Metcash Limited - CEO of Australian Liquor Marketers [4]

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Thank you, Jeff. So 6 months in, taking over a business that's been well managed and, as Jeff stated, 6 years of consistent growth, I'm very happy to be here. The retailers are welcoming. Their purpose and their passion has certainly come through and so has the team's.

Of course, the retailers have made me feel very, very welcome. I've been traveling around many stores. And I believe that the partnership's sound. Some of the stores I've seen have been wonderful. The investment and the commitment to the customer, in my mind, is second to none.

In the 6 months, I've seen some opportunities, those opportunities being driving digital, particularly in e-commerce and loyalty, growing Private Label, and ensuring that we focused on the on-premise business.

I'll pass back to Jeff.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [5]

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All right, very good. Thanks, Chris. So just now moving through the outlook statement.

So the growth in Supermarket wholesale sales, ex tobacco, reported in the first half '20 has continued in the first 5 weeks of the second half '20, excluding the impact of Drakes. Supermarket sales in the second half will, however, be negatively impacted by the ceasing to supply Drakes in SA. While the group will continue to look for opportunities to exit onerous lease contracts, the contribution to profit in future period is expected to reduce. A continued focus on costs is expected to help offset the impact of cost inflation over the remainder of financial year '20.

And in Liquor, we expect market growth over the remainder of financial year '20 to continue to be influenced by the premiumization trend, higher quality but lower consumption. The business is continuing to progress its growth initiatives under the MFuture program with opportunities in Private and Exclusive Label, the on-premise market and digital being prioritized under the new CEO.

In Hardware now, trade sales over the remainder of financial year '20 are expected to continue to be impacted by the slowdown in construction activity. Our non-trade sales are expected to be less impacted than trade sales due to the level of DIY activity and acceleration of the Sapphire store upgrade program. The business continues to have a strong focus on costs to help offset the impact of the slowdown in construction activity. The medium- to long-term market fundamentals remain positive, with construction activity expected to be underpinned by population growth and an undersupply of housing.

So that's it for the presentation. We'll now open it up for Q&A. As I said, we've got the business CEOs here with us, so we'll also ask them to contribute during the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Keegan Booysen from Jefferies.

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Keegan Booysen, Jefferies LLC, Research Division - Equity Associate [2]

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Firstly, just on Hardware, a good result given the tough environment. I was hoping that you could give us some color on the individual drivers of earnings. You've mentioned that there were some synergy benefits, some other cost mitigation efforts. Maybe if you could break some of these out for us and how we should be thinking about the cost base going forward?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [3]

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Do you want to say anything, Mark, or?

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Mark Laidlaw, Metcash Limited - CEO of Independent Hardware Group [4]

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I'm happy to. It's as you've really outlined there I think, Jeff, isn't it?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [5]

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Yes. Yes. I think we've tried to call that out in the presentation. So I don't know if there's anything specifically you wanted to...

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Brad Soller, Metcash Limited - Group CFO [6]

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So the only thing that's worth actually calling out, Mark, if you actually look at it in terms of our results, guys. So there was some roll-forward in terms of the HCH synergies that have actually come through from last year. We would have carried forward -- benefit was about $2.5 million to $3 million actually coming through. So that actually has flown through into this rate -- into our results this period.

The other key impact as you actually go, when you look at the change in sales, that's actually -- most of the decline has actually come through the trade sales, and most of the trade sales that actually had a decline has actually come through. We have a big presence, as you saw in terms of the corporate stores. So we actually got quite impacted on that. And that was the key delta in terms of our numbers. So the offset from the lower sales and lower margin, I think Mark and his team have done a fantastic job in taking costs out to actually limit the decline to where we've actually got to.

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Mark Laidlaw, Metcash Limited - CEO of Independent Hardware Group [7]

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And the only thing I'd add to that, Brad, is in terms of the cost, we've received those benefits through the supply chain. So really when we did take the 2 businesses on, we had 7 warehouses, and we're now down to 4. And I think [there's 1 place] -- there is 1 further warehouse to close over the next 12 months, which will be in Western Australia.

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Brad Soller, Metcash Limited - Group CFO [8]

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So I hope that helps.

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Keegan Booysen, Jefferies LLC, Research Division - Equity Associate [9]

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Yes. Yes. Fantastic. And the second one, just on food. Customer losses are going to be a key risk going forward. I was looking to get some clarity on the enforceability of the supply contracts you've entered into in SA, in Queensland. The Drakes have been quite vocal about breaking the Queensland supply agreement, if it can supply its network elsewhere. I was just interested in what the terms were, obviously understanding confidentiality, just on the major supply agreements you've signed up in SA.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [10]

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Yes. So I think, obviously, we just announced that we had signed that agreement with Drakes for a 5-year supply. So I don't have any other comment on that.

I think the other supply agreements, obviously, we have -- the big one there would be FoodWorks. Scott, so I don't know if you want to just -- I know you feel like the relationship's good there and things are going all right. So if any comments you want to make?

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Scott Marshall, Metcash Limited - CEO of Food [11]

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Yes. So we've said before that FoodWorks' contract, in its current form, finishes in September next year, and it's a 12-month rolling contract, and we're in discussions with them. And I wouldn't comment any further other than to say that we've had a long relationship with many of those customers, and we'll work with them to get the best outcome.

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Brad Soller, Metcash Limited - Group CFO [12]

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And there are some real positives I think coming through. So if you look in terms of South Australia and the commitment that South Australian retailers actually gave us when we wanted to actually commit to the new DC, so all of those retailers down there outside without -- with the obviously exception of Drake, did actually commit to us with fairly long-term supply agreements.

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Keegan Booysen, Jefferies LLC, Research Division - Equity Associate [13]

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Well, I'm just -- I guess I'm just trying to understand a bit more about the enforceability. I mean is there any way they could exit these contracts? What are the consequences? Is it rock-solid? Or is there something else that they can do to leave?

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Brad Soller, Metcash Limited - Group CFO [14]

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We're not going to comment on the actual contracts, but it will be actually -- absolutely the terms actually do deliver them value for money. We think we're doing a really, really good job in getting the products to them and offering them a great service, and we'll continue to work incredibly hard to actually -- to do that. We enter in a contract with both parties in good faith, and we expect both parties to stick to those contracts in good faith. We're not going to comment on individual terms of the contract.

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Operator [15]

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Your next question comes from the line of Ben Gilbert from UBS.

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Ben Gilbert, UBS Investment Bank, Research Division - Executive Director and Analyst [16]

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Just the first one just around the provisions, in terms of the unwind there. How should we be thinking about that looking forward, Brad?

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Brad Soller, Metcash Limited - Group CFO [17]

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Yes. So in terms of the impact that it actually had in the half, as I said, we actually called out the $10 million that actually -- that unwind. Just to remind you all of the numbers, Ben. So last year, it was $16 million in the first half and $10 million -- that has come down. And we've actually seen that actually unwind to the extent of around about $10 million. Last year, in the second half, it was only around about $2 million. So we wouldn't expect to see a material impact in terms of the delta in those provisions between the first and the second half, Ben. So I think hopefully, the noise of that has actually found its way out of the system.

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Ben Gilbert, UBS Investment Bank, Research Division - Executive Director and Analyst [18]

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So we should think a couple million bucks roughly in the second half?

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Brad Soller, Metcash Limited - Group CFO [19]

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Yes.

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Ben Gilbert, UBS Investment Bank, Research Division - Executive Director and Analyst [20]

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Cool. And just to say -- the other one is around tobacco. You obviously make some reasonable sort of stock profits around that, which is in the base. How is the way you think about that looking forward with the 7-Eleven contract going, because obviously a big chunk of those sales were tobacco? Is that going to impact the stock profits? Will there be a one-off impact so it has to be rebased for the tobacco earnings?

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Brad Soller, Metcash Limited - Group CFO [21]

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So when we've actually determined that number that we actually gave you, Ben, on the $15 million in -- of earnings, we've taken to -- into account all the earnings that we actually make from 7-Eleven. And that, obviously, given the -- it is predominantly tobacco sales to 7-Eleven, it does include whatever earnings we get from tobacco related to 7-Eleven have now been removed from that number. Included in that number is a better way to use the word.

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Ben Gilbert, UBS Investment Bank, Research Division - Executive Director and Analyst [22]

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Okay. And just -- the final one from me. Just interested around online, the strategy for Food around online because you've obviously probably -- or you're arguably in a better position than lots of your competitors in the sense you've sort of [single peak] capability in the distribution network. What's the thinking around moving more into online within the grocery space or even partnering with someone?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [23]

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Yes. No, that's -- look, a lot of our -- we've called out before, a lot of our retailers are doing that themselves already. But I'll just let Scott sort of give you his thoughts about the future on that.

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Scott Marshall, Metcash Limited - CEO of Food [24]

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Yes. So we called out back in March that, obviously, we were going to do a piece of work on what the future of digital look like, and we're doing that. And there's not really an update other than to say we have retailers in the network sort of circa 300 doing online at the moment in their local areas. We've got retailers trying click & collect. And we're building the loyalty platform so we can gather the IGA Rewards, so we can start gathering shopper data and move ahead in that space. So at the moment, it's play on, and we'll definitely update you as we get more developed in that strategy.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [25]

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Yes. And I guess just to add to that, Ben. So Chris has told you, he's come in, and that's obviously one of his priorities, and there's more liquor sold online than there is food. And so it's a big opportunity for us in Liquor. But clearly, as Scott said, we're reviewing that strategy in Food as well. But we're absolutely getting on with it now, and Chris is looking at how to accelerate that on the Liquor side. And there's a big pull from the retailers on the Liquor side as well because they see that as a huge opportunity for them to grow their sales.

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Brad Soller, Metcash Limited - Group CFO [26]

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And Mark's business is in the Hardware business (inaudible).

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [27]

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Yes. And Mark's still doing well. Yes, absolutely. Mark's business is still going well online.

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Ben Gilbert, UBS Investment Bank, Research Division - Executive Director and Analyst [28]

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Would you be open to a partnership with someone like Amazon if they approached you?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [29]

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Look, we haven't had any discussions with anyone. So it'd be difficult to comment on that.

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Operator [30]

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Your next question comes from the line of Shaun Cousins from JPMorgan.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [31]

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Just a question regarding cash flow. Apologies, I may have missed part of this. But just on your cash conversion, you've highlighted historically, 90% is where it should be, and it's been a little higher because you've been quite efficient. Going forward, you should have some working capital investments that have contributed to the weak cash result this period. Does that 90% cash conversion target still hold? Or as you continue to invest in working capital, should that see future cash conversion estimates to be more around 85%, say?

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Brad Soller, Metcash Limited - Group CFO [32]

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No. So what -- just so, Shaun, you understand how we actually manage it. So we give our pillars and our businesses pretty strict targets in terms of their working capital position that we actually want them to manage to, and we expect them to actually stay within those numbers. What we actually did, we made a conscious decision to actually give them more capacity in this area because there were some efficiency issues that were coming out when we actually drove it down as hard as we actually did. And weighing it up and looking at the cost of debt in terms of what it is, we deemed it to be an appropriate investment.

I don't think you should see -- because we're still comparing to a balance at the end of FY '19, you should not expect a reversal of any significant change for the balance of this year. But then it [comes] in the system, right? And you're starting from the same working capital balance, and we will then absolutely expect to go back to the 90% when we get into FY '21 again.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [33]

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Okay. So effectively a cash flow -- a cash conversion metric similar to the first half '20 should be expected in the second half '20. Is that -- and then we go to 90%. Is that the way to think of it?

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Brad Soller, Metcash Limited - Group CFO [34]

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I think that's a fair assumption when we actually go through. Maybe we should try and do a little bit better than that, but we'll see. That is a working assumption. And when we go into the following year, we absolutely expect it to actually go back to the conversion of 90% because we -- I'm looking at my colleagues across the table here, we are not going to actually give them another step-up in their working capital investment.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [35]

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Okay. Great. My second question is just around MFuture. And I'm just not sure I could see the quantification of the cost savings that have been realized in the first half '20. I think the guidance you've provided is $50 million over 2 years. And apologies if it's in the slide deck, but can you just indicate what the cost savings realized in first half '20 was, please?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [36]

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Yes. So I think on Mark's business, obviously, we called out some of the work that's taken place there. But -- and there is one bullet point under Food, where we do say that we partially offset the decline on the EBIT side by some of the cost work. So we've had very good work from Scott and the team, I know, in logistics savings. We didn't put anything specifically on that, Shaun, except to just say that we're on track to deliver what we said at the Strategy Day.

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Brad Soller, Metcash Limited - Group CFO [37]

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So it's worth -- I can take you through and give you rough guidelines in terms of where you actually get the numbers to give you some confidence that we actually got the numbers out. Because if you look at our cost of doing business number, I think we last year ran that number. Our cost base is about $1 billion. The actual number last year was $465 million. If you run inflation through those numbers, they will run through at $12 million, $13 million, somewhere around those numbers. You actually adjust it for the reduction in one-offs, it's another $10 million, $11 million. So if you actually take those 2 numbers through, you can actually see at least $10 million to $11 million of costs have actually come out of the business in the first half. That, if you actually put that into a run rate for the second half, you're getting very quickly to that $25 million number we actually guided to -- you to. So we're very confident we're getting those costs out of the business.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [38]

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Great. And I guess my third question is just around tobacco. How big, maybe post 7-Eleven, is that as a proportion of sales? And have you seen any transition to illicit -- or pardon me, typically, tobacco has been a weakness for Coles and Woolworths and some of the tobacco companies have highlighted illicit tobacco as growing as the inflation is starting to catch up with volumes. Are you -- maybe what's the size of your tobacco sales now, and maybe have they been growing or declining on a dollar basis, given the continued excise increases, please?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [39]

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Yes, the guys are just scribbling down a few numbers here. So we had called out before that it was about 30 -- 30% of the sales was in tobacco. So obviously -- and we've said that the 7-Eleven volume was the majority of that, so it'd be sort of 2/3 or more was in tobacco. So if you do the math on that, which the guys are doing...

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Brad Soller, Metcash Limited - Group CFO [40]

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[I'm going to] do the math for you. So basically, what you can actually do is -- the numbers we've actually given you previously is roughly, if you look in terms of the overall business, both Supermarkets and Convenience, not just Supermarkets, both of them, the actual percentage that we actually said was a tobacco mix, was around about -- just around about 30%, just over 30%, a touch over that. So we also guided you in terms of what the actual loss of sales from 7-Eleven, $800 million, predominantly tobacco, and then adjust that applied to our sales and you'll actually get a revised percentage. But we've never given the exact numbers, and I'm trying to actually work it out in my head, but I couldn't actually work it out quickly enough for you, but I'm sure you can.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [41]

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And did tobacco grow this year for the first half or...?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [42]

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It continues to be where the number of sticks are going down, but the -- because of the increase in price, obviously, you get a value growth there but not volume growth.

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Operator [43]

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Our next question is from the line of Andrew McLennan from Goldman Sachs.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [44]

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I would like to continue on with the operating cash flow. Well, in fact, the working capital investment. Brad, I know you're pretty tight with the purse strings. I was just wondering if you could sort of explain a bit more how you've made this change, when you made the change, and what kind of impact it is making to each pillar's sales line or whether or not we've seen a full impact that's come through in this half.

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Brad Soller, Metcash Limited - Group CFO [45]

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Yes. So in terms of where we've actually made the change, it's -- the change is coming back for couple of reasons. So in the Food pillar, it was predominantly high. I truly believe we drove it too hard. And actually, sitting down with Scott and his team and stepping back from it, looking at how -- where we actually got to, we genuinely allowed that number to actually go out.

I think in Mark's case, it's -- in the Hardware, the delta actually came around more as a result of acquisitions that we've actually done, so we actually had a couple of acquisitions. There were retail stores. So the acquisition of retail stores has the highest stock position than it actually was in the warehouse. That drove Mark's numbers up, so we adjusted Mark's numbers.

And Chris, we haven't given you much leeway, I'm afraid. So the Liquor...

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Christopher William Baddock, Metcash Limited - CEO of Australian Liquor Marketers [46]

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Yes. We have grown though across [from these] ranges.

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Brad Soller, Metcash Limited - Group CFO [47]

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So that's the delta. Also, we've obviously seen ourselves tipping up as well. The tip-up in our sales will actually require us to actually fund more working capital.

So I think it was the right decision to actually make. We have -- the question that we have, have we seen the benefit, I think Scott has done a fantastic job in actually getting his business humming. I can't take any credit for it in terms of the actual increase in the growth and give him more working capital balance, but I'm sure that fact that, that stock was available would have actually helped Scott service his client base better.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [48]

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Okay. And so you're saying that the working capital change or the allocation was made, so, earlier in the financial year? Or has this been more recent?

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Brad Soller, Metcash Limited - Group CFO [49]

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No, no, no. So effectively, it's gone -- it wasn't a loss. It has gone through effectively most of the whole of the first half of the financial year, yes. Pretty early in the year.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [50]

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Got you. Righty ho. Okay. And then also, just in relation to the refurbs, the 15% pickup in sales versus more like 10% historically. Can you explain what is driving that better outcome? I imagine the theory would be that as you're refurbing into sort of the second-tier stores that, that performance will actually go the other way. So quite a surprising outcome.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [51]

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No. But I think if you remember back to the Strategy Day, Andrew, we said there that the original group of DSA stores were being -- where the retailers came forward and sort of self-selected to do it. But when we did the analysis across the network, we could see 500 stores that would benefit from doing the DSAs. And there were some very good stores that were in that group. So what we are seeing now is some of the better stores coming through that we've gone to them and said, "Look, you'll get a big sales increase if you do the DSA."

The other thing is probably there's definitely a factor around we've learned a lot as well as we've gone through these. So the quality of the DSAs that we're doing is improving as we go through them as well.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [52]

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And Brad mentioned earlier -- just a final one, if that's okay. Brad mentioned earlier that you're still not needing to fund these DSA programs. I mean what's been the process there? You've gone and demonstrated to these independent grocers that there's a good opportunity through a DSA program, and they've been happy enough with the noncapital terms of the agreement? Is that effectively what's been happening?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [53]

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Yes -- no, look, I think we've provided options to them because that's what the retailers have asked us to do. But what we're finding is because they're seeing other retailers that are doing well out of this, the guys are holding up their hands and saying, "Yes, I'll do it, and I'll pay for it." And then obviously, there's rebates that we pay back to the guys that do that when they do them themselves. But no, that's -- the funding requirements that we thought has changed, but that may change again. That's the reason Brad said on the outlook for CapEx that we may see that step up in the second half of the year.

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Brad Soller, Metcash Limited - Group CFO [54]

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And if you recall, we actually said in terms of the money we actually lent -- we were going to loan them, we're always going to loan them money at a rate higher than the banks were going to loan them. So we expect it to actually cover a -- get a tick-up in terms of the loans. And I think I prefer this model. I think the guys actually have done a good job in actually selling this model there because there's much lower risk to us in terms of we aren't putting any capital upfront and only rewarding the retailers for performance. So well done to Scott and the team for holding the line.

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Scott Marshall, Metcash Limited - CEO of Food [55]

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Yes. And I'd just add on that. The only build, Andrew, is that once we are showing the retailers good data that shows the opportunity and because we have some good benchmarking to compare that with, they're believing they're going to get the growth. So we're seeing that momentum continue.

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Operator [56]

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The next question comes from the line of Bryan Raymond from Citi.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [57]

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My first question is just on the teamwork score in Food. It improved by about 200 basis points, up 74%. I just wanted to know what drove that. If there's any categories or any of the -- any other specific balance which may have driven that and also whether it looked any different if you exclude tobacco?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [58]

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Yes. No, it wouldn't on -- if you exclude tobacco. I think I mentioned as we've gone through the presentation that it is the result of improving the ranges that are in the warehouse. And again, since Scott's come in and Grant Ramage and his team, they've been working very closely with a number of the suppliers who had left the warehouse to go direct, and they're coming back into the warehouse now because they see the benefits of doing that.

So I don't know, Scott, anything you want…?

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Scott Marshall, Metcash Limited - CEO of Food [59]

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No. Just to build on that, I think there's a couple of elements. And I mean, exactly what Jeff's saying about increasing the ranges in our shed so that we've got the right products available for the retailers to buy so they don't have to go outside the network and then working with our retailers. So I think the relationship's improving a lot, and we're working in conjunction on range and price, and that's driving the like-for-like sales and the teamwork score.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [60]

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Would the working capital investment have helped the teamwork score? I'm just trying to think about it, the operating metrics that underpin your business and the ROI on that investment in working cap, is that something we should see because you had [some] out of stocks previously in the warehouse that you're now able to fulfill?

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Scott Marshall, Metcash Limited - CEO of Food [61]

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I think it's hard to quantify or draw a straight line between those things. But it is a combination of many factors that have helped drive it, so not just the working capital.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [62]

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Right. Okay. And then just on the Drakes' impact of $1.5 million. Is there any reason why we couldn't just annualize that 1-month contribution of $1.5 million to get a full year contribution of $18 million there?

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Brad Soller, Metcash Limited - Group CFO [63]

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So in terms of this round about $1.5 million, we're not going to give you a full year forecast in terms of that. [Actually Drakes had] actually had got the numbers. Last time when we actually did it, Bryan, you guys got to a range of $15 million to $20 million, and we said to you a range of $15 million to $20 million was a reasonable set range to actually get to. So if you multiply that number by 12, you're getting to the range of $15 million to $20 million. So I guess, you can actually just multiply it by 12.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [64]

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Good. Just making sure. And then finally, just in terms of the trade market within Hardware, obviously, it's in a bit of a tough spot at the moment. Just wondering about your appetite for further acquisitions there. There was obviously some mention about it this week in the press with you connected to it. Just wanted to hear -- do you think that's something you would entertain? Or if other acquisitions would be on the radar that are a bit more sizable than what you've done today within that business, excluding HTH, of course?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [65]

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Well, look, I think, as we said, we're very positive about the long term, even the medium- and long-term aspects in that business. And it is still a relatively fragmented market, particularly on the trade side, which is where our strengths are. We don't comment on rumors. But obviously, we're willing to talk. And if we can find a deal out there that helps us accelerate on our strategy and it's done at the right valuations to add value for our shareholders, then we'd certainly be interested in doing it.

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Operator [66]

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Your next question comes from the line of Richard Barwick from CLSA.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [67]

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Can I just clarify the acquisitions? You said you talked about acquisitions within Hardware. And obviously you picked up the remaining 51% of Gay's hardware. Was -- were there other acquisitions as well within that? I'm just trying to get a sense of what the EBIT contribution might have been from these acquisitions in the half.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [68]

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Only small ones, Richard. So they were the 2 major ones. What happens, again, as we've talked about before, with succession planning issues, there was a store in Portland, in Victoria where the owner reaches an age and doesn't have a succession plan. So in that instance, we do become that succession plan and roll it into one of our joint ventures. And I think there's another small store in Queensland called St. George, I think was the other. Two very small acquisitions.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [69]

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So Gay was the big one, then 2 other small ones?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [70]

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Well, Keith in South Australia was documented. That was the last one.

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Brad Soller, Metcash Limited - Group CFO [71]

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Yes, Keith Timber (inaudible) off your numbers, so effectively, it came too late in the piece.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [72]

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Yes. And the materiality of all of those, that would be -- it would be small. Yes, very small.

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Brad Soller, Metcash Limited - Group CFO [73]

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G. Gay's the main one. You are correct.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [74]

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Okay. All right. And can you just explain a little bit more on this? The $15 million net impact from the 7-Eleven contract, I mean I'm surprised it's as high as that. And obviously, you talk about that being net, so that's after some cost saves as well. Again, because if the sort of rule of thumb that I had worked on, maybe mistakenly, was that tobacco sales was about 1% EBIT margin. So it does suggest there's some real -- there's actually some material other costs being captured here as well. So can you give us a little bit more of a breakdown in terms of how you arrive at the $15 million, or what are the biggest components of that, just so I get a sense of how the -- sort of works from a I guess a deleverage or some stranded assets or -- the various components?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [75]

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Yes. No, look, I think $15 million, the reason we've given a number is because we saw a range that was very, very broad there. And we did say on that $800 million, predominantly that was in tobacco and that is a low-margin business. So if you just sort of worked through that, you are going to get somewhere around $8 million or so. And then there is some stranded fixed costs that we end up with in the -- on the business on that kind of volume. So we're just trying to give you guys some -- rather than just give you the goodwill impairment number and you try to figure it out from there, we wanted to give you really some specific sort of guidance around that one.

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Brad Soller, Metcash Limited - Group CFO [76]

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But you've got the number right. You've got the -- if you take the margin that we actually got, you add the stranded costs to it because there's -- it does actually contribute -- $800 million worth of volume does absorb some fixed costs as you go through. So if you add those 2 numbers together, you'll get roughly the number we actually gave you.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [77]

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Is there an impact also from a loss of buying power? I mean so now that supply is going -- okay, well, you have $800 million revenue less, so you're going to be buying on weaker terms?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [78]

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Yes -- no, look, the -- there's not a loss for us at all in that space, and we'll continue to work with suppliers in the current form. So the short answer's no.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [79]

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Okay. And I recall, I mean, when it was first announced, you saying that there's -- you're reluctant to give a number because there were still negotiations going on as far as the WA contract and some other categories in the East Coast. Now that you have given a number, I mean does it -- does that say anything? Is there any implications for the WA or the remaining East Coast categories? Where are you with that? Or -- and when would you expect resolution if it hasn't been resolved already?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [80]

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Yes. No, those discussions are ongoing still. So we'll see where we get to in the conversations with 7-Eleven. They said that when we -- Scott and I met with them. That conversations were going good on those parts of the contract. So nothing further that we can update at this time, except that we're still discussing that with them.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [81]

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Okay. And just a couple of quick ones on the Diamond Store Accelerator. Obviously, you're basically at 450. You've talked about how many stores are in progress. Is this something -- I mean have you given a number in terms of where you think you will get to on a 2- and 3-year-type view? I mean -- and ultimately, will all stores be achieved or basically go through the program?

And I'd love to hear a little bit more color around the sales uplift. Is that sort of an immediate step-up? Is it -- or do you get the initial lift and then into year 2, and perhaps even year 3, do you see some sales benefits from the Accelerator?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [82]

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Yes. So I'll give a few comments and then hand over to Scott. So yes, look, I think when we did the Investor Day, at that time I think we said we were at around 350 or 400 or something that had been through the program and that we could see another 500 that would benefit from doing the DSA. So -- and our plans would be, as we said, to try to accelerate those and do those as quickly as we can because of the benefits that we see coming through in those stores that do the refresh.

We re-spaced the stores to get them correct for basically the way that customers shop now. So that would be adding more space back into like fresh categories because that's growing areas, and then we do what we call rightsizing for the other categories. So you bring some of the other categories down to the space they need to do the sales, but then reinvest that space back into the growth categories.

So do they see the immediate uplifts? Yes. And do we -- then, do they maintain it? From what we've looked at -- Scott, I think you've had a look at it, that yes, stores don't go backwards from that point. I mean, obviously, if you get impacted, that would have an -- obviously, you'd take an impact from a competitor opening or whatever. But I don't know, Scott, anything you want to...?

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Scott Marshall, Metcash Limited - CEO of Food [83]

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No, I think that's where we're at. The stores definitely are getting that additional uplift we're seeing because, as I said before, we're adding in range and price, and it is quite immediate. And we have said previously that the second year, we seem to get down into the single-digit growth. But it is resetting the store.

I think your first part of the question was about how many more stores. Jeff called out the 500. I think we'll always be working with the retailers to continually refresh and update the stores. And that will just create continual opportunities for us with our retailers.

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Operator [84]

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Your next question comes from the line of Phil Kimber from Evans & Partners.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [85]

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Just a question on the inventory investment. I get all your comments around the cost of funding is very low, but to what extent is it related to some inflation coming back into the category? I mean has that basically seen your inventory lift up because of that inflation?

And then I guess, secondly, are there sort of more opportunities going forward for you to buy ahead of some of these price rises and maybe use that to help with the earnings of the business?

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Brad Soller, Metcash Limited - Group CFO [86]

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Yes. So in terms of the inflation, I think it's hard to quantify net impact because you actually have to adjust for the other side, for the credit side as well. So it's a bit hard for me to give you a number. But I'm sure they actually must have contributed a little bit, too. I don't know what the actual number it actually did contribute to.

In terms of price escalations and how we actually manage our purchases and timing of those purchases, I'll let Scotty talk to that.

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Scott Marshall, Metcash Limited - CEO of Food [87]

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Yes, just we'll always take sensible opportunities to buy well, but you can see the shift. Also, we don't want to rely on buying well, we want to rely on selling. So that's the key focus.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [88]

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Okay. So it's not like a major change. And then was it new inventory that you bought? So you're expanding your ranges? Or did you just increase the depth of your existing sort of SKUs?

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Scott Marshall, Metcash Limited - CEO of Food [89]

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It's a bit of a mix of both, to be fair.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [90]

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Okay. And then if I can, just a question on the onerous leases. I mean there's a sort of note in the accounts and if I take that at face value, it looks like it actually in the second half last year was a positive number. So it didn't actually help, it hurt your earnings. I think it was $16.6 million in the first half, $13.3 million for the full year. So actually that would imply, in the second half, it didn't help your earnings at all. Is that right? Or is there something else?

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Brad Soller, Metcash Limited - Group CFO [91]

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Maybe we should have put brackets around those numbers, but we -- it is actually a credit in terms of the number. $16.1 million is a credit.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [92]

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No, no, I understand that. But if you then take the full year for '19, which was $13.3 million, it means that you didn't have a credit in the second half, you had a debit. So it hurt profit in the second half last year. So I just -- are those numbers sort of running -- are those onerous provisions that you talk about, that there was an abnormal amount in the first half last year, the normalized rate's about $10 million a year. Is that only going through that line that we can see in the notes of the accounts? Or are there other places where that's sitting because sort of...?

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Brad Soller, Metcash Limited - Group CFO [93]

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It's only there. So in terms of actually the impact of those numbers, which we focus on predominantly, are the Supermarkets business. There were some small changes through some of the other pillars, which were not actually that material, but that is the only line that it actually has come through. In terms of the actual -- the delta that's actually impacted Supermarkets, it is absolute -- definitely $10 million in the first half.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [94]

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In the first half. And so when you say going forward it's going to get smaller, I mean there's 2 parts of this line. I assume there's a normal provision release every year that, I think, from memory, and correct me if I'm wrong, is about $10 million. And then there's potentially periods where you might get out of a lease and you have to write-back over and above the normal amount of provision release, and that's what happened in the first half last year. So with your outlook comment, are you just saying that the ability to write-back above that $10 million is getting smaller? Or are you saying the $10 million is getting smaller each year?

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Brad Soller, Metcash Limited - Group CFO [95]

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So in terms of -- you're absolutely right. And in terms of this, there's been 2 components to it under the existing accounting standards. And what we -- and those will be -- continue to actually be released and protect the P&L account.

And that if you recall, Phil, was the reason we called out the delta between 100% and 90% cash conversion because we actually had some shelter in the P&L account. All we're actually referring now is when we have an onerous lease obligation on lease, and we come to an agreement with the landlord or the retailer and therefore that provision is no longer required and actually gets released in one big go. That's all we're talking about...

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [96]

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So you're talking about the extra bit going forward is going to be smaller or maybe nothing, but the underlying amount will continue going forward? I just want -- I think that's what...

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Brad Soller, Metcash Limited - Group CFO [97]

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Absolutely. Absolutely. And the only caveat I put to this is AASB 16 has thrown it into a different accounting treatment. So under the new accounting treatment, one of the impacts of that is that, that release going forward, and following the introduction of AASB 16, is likely to be smaller. But when we talk through the balance of the results for this year on a pre AASB 16 basis, you're absolutely right.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [98]

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When you say smaller, like a material amount? I mean it was only about $10 million a year. I mean is it going to be...

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Brad Soller, Metcash Limited - Group CFO [99]

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No. So it's all wrapped up in that total adjustment that we actually said to PAT of $15 million. It's part -- it's included in that number as well.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [100]

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Okay. Yes. And then one last one quickly, if I can. Just -- it's great that wholesale sales ex tobacco have actually gone positive. I think you've called out first time since FY '12. Can you give us a bit of sort of commentary geographically? Is that just WA and SA getting a lot better because I think they were dragging you down in the past? Or is it across the board that you're seeing that pick up?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [101]

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No. I think if you look at the comments in and around Food sales, we said that Queensland was actually the strongest performing state. But also the SA Foodland guys, ex Drakes, were performing well. And just going back to -- we haven't broken it out by state because we don't do that. But WA, which was a big drag on our numbers, which we've called out for a long time now, has gotten themselves back to flat. So it's a significant turnaround in WA.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [102]

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Okay. That's great. And that -- is that -- I mean I think previously you'd called out it was economic factors that were driving that. Do you think that's what's changed? Or is it more your own initiatives that have seen that come back to flat?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [103]

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No. Well, we -- look, we said before that there was a number of factors in WA. It wasn't just the economy. But it was also that we had some people in the network that were struggling, so we had a number of stores out there that we had to get out of. You had the impacts from Aldi, which was rolling out very quickly for a number of years in WA that was impacting the retailers out there. And then some of the work that Scott's talked about, which is, actually, we've been working very closely to get the retailers more competitive. So we've been getting our prices and our ranges right. And so the economy's gotten a bit better, the impacts have gotten a bit less, the network has gotten cleaned up, and we're making the retailers more competitive.

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Operator [104]

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We have a question from the line of Johannes Faul from Morningstar.

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Johannes Faul, Morningstar Inc., Research Division - Equity Analyst [105]

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I had one for Mark on Hardware. And I understand that the trade sales account for a bit less sales than they have last year and also cyclical factors are at play there. But also the leading hardware retailer has said it's trying to pivot or pivoting to the trade side as well. Have you seen more competition on the trade side? Or put differently, are you losing share in trade? Has that impacted that as well?

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Mark Laidlaw, Metcash Limited - CEO of Independent Hardware Group [106]

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So good question. We're clearly not losing share in trade. There's a lot of market-related factors. I think we all know this. October last year, we're very concerned when we saw new housing approvals go from 230,000 down to 190,000. So there was a 20% drop in new housing approvals. And some of our competitors have actually reported in that trade space that they are down 20%. So we are very encouraged, I must say, by the result that we've reported at the half.

I must say, we don't see -- we see there will continue to be headwinds ahead for the next 12 to 18 months. So all we can do at this stage -- we've got a good business here, all we can do is continue to tighten the belt and wait for the market to go on that cyclical upswing, and we'll be ready to take full advantage of that when it happens.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [107]

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Okay. Very good. Well, I think that's all of the questions that we've had, and thank you for joining us this morning. And I know that we'll see a number of you as we make our way around over the next few days. Thank you.