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Edited Transcript of MTS.AX earnings conference call or presentation 22-Jun-20 12:30am GMT

Full Year 2020 Metcash Ltd Earnings Call

Silverwater, New South Wales Jun 22, 2020 (Thomson StreetEvents) -- Edited Transcript of Metcash Ltd earnings conference call or presentation Monday, June 22, 2020 at 12:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Annette Welsh

Metcash Limited - CEO of Independent Hardware Group

* 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

* Scott Marshall

Metcash Limited - CEO of Supermarkets & Convenience

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Conference Call Participants

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* Andrew J. McLennan

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

* Bryan Raymond

Citigroup Inc, Research Division - VP & Analyst

* David Errington

BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia

* Grant Saligari

Crédit Suisse AG, Research Division - Head of the Consumer Staples, Discretionary Retail & Agriculture and Director

* Michael Simotas

Jefferies LLC, Research Division - Equity Analyst

* Phillip Kimber

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

* Richard Barwick

CLSA Limited, Research Division - Research Analyst

* Ross Curran

Macquarie Research - Analyst

* Shaun Robert Cousins

JP Morgan Chase & Co, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by and welcome to the Metcash Full Year Results Analyst Briefing. (Operator Instructions) I'd now like to hand the conference over to your first speaker, Mr. Jeff Adams, Group Chief Executive Officer. Thank you. Please go ahead.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [2]

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Good morning, everyone. Thanks for taking the time to join us this morning to go through the Metcash Financial Year '20 Results. I hope all of you, your colleagues, family and friends are -- remain safe and healthy during these unprecedented times. I'll talk to you through our group and pillar results this morning and then hand over to Brad to discuss the financials with you, and then I'll cover off our outlook statements before we take your questions.

With Brad and I, this morning, we have our business CEOs: So Scott Marshall, CEO of food. Scott has been a couple of years in the role now. Chris Baddock, who is our CEO of Liquor and just coming up to the end of his first year with us. And our new CEO of Hardware, Annette Welsh, who has taken over for Mark Ledlow when he retired at the end of February. Annette's not new to the business, having worked in the Hardware team for about 10 years. So knows the business, the market and the retailers extremely well, and was, most recently, the GM of merchandise and hardware before her appointment. So welcome to Annette in her new role. Besides Brad and myself, we will also involve the CEOs in helping to answer your questions at the end of the presentation.

So just turning over now to our purpose, vision and values. No changes to this slide. However, I would like to call out from the start, this has probably been the most challenging year any of us has ever seen and really brought home our purpose of championing successful independence. I'll talk to you about what I mean by that as we go through the presentation, but let's start on the next 2 slides, where we call out some of the points of why FY '20 was such an unprecedented year.

I've been catching up with our teams across the group by video, which I think we've all gotten quite good at now. And I've been telling them, I've been around a while, and I've never seen a year like this one.

Going back to last winter, we were all dealing with the terrible effects that multiple years of drought had on many of the communities that we serve. Significant efforts were going in from our state-based teams to supporting both our retailers and also to support those impacted communities.

Of course, that was all forgotten by the time we got towards the summer and had one of the worst bushfire seasons anyone had seen for quite some time. I joined many of the crisis calls that were taking place across our businesses through December over the holidays and into January, and personally heard the ways our teams and our retailers were going above and beyond to support the local fire services and their local communities. I heard the extraordinary efforts that were being made from across the group to make sure the local communities had the supplies they needed during these tragic events. We've listed a few of the points on this slide talking about those efforts. But if you have a moment, you can read more of those stories on the link we've provided on this slide.

And of course, then we had the COVID-19 pandemic. I don't think any of us could have imagined in January and early February with the stories coming out of China that a short time later, we would be dealing with a global pandemic that the world had not seen anything like since the early 1900s. Very early in March, we recognized a critical role that we and our retailers would need to play through this crisis in supporting the communities that they serve. As a result, we quickly reset our priorities across the businesses to the 3 listed at the top of Slide 4: protecting the health and well-being of our people, so they could continue to provide an essential service; doing whatever we had to do to make sure we kept our supply chains open and DCs running to ensure they could continue the delivery of essential goods to our retailers; and to make sure we remained in a strong financial position, protecting our balance sheet, so that we can make sure that our supply to our retailers was not interrupted.

We've listed a few of the highlights there of our efforts during early March and into April, but honestly, it's hard to summarize that into a few lines. Overall, I'm very proud of the way the whole group and our retailers rallied together during this crisis and really lived our purpose of championing successful independence, so they could do what they do so well in supporting their local communities. It has truly been an unprecedented year.

So just moving on now to the slide titled group highlights. Group revenue increased by 2.9% in the year and up 2% when you include charge-through sales to $14.9 billion. And as I just discussed, all of the businesses worked very hard during the unprecedented challenges of the past year to service our retailers.

Our food business continued the sales momentum we had in the first half of the year even before the COVID-19 uplifts of March and April, reporting underlying sales growth for the year in wholesale sales ex tobacco for the first time since financial year '12 confirming our strategic initiatives are delivering positive results.

Liquor was impacted in the last 5 weeks of the financial year by the shutdown of our New Zealand business and the on-premise business in Australia, but still delivered its seventh consecutive year of sales growth.

Hardware returned to sales growth in the second half of the year driven by very strong DIY performance. Our underlying group EBIT improved by about $12 million when you account for the reduced provision releases in this financial year and the loss of Drakes from the 30th of September.

We've reported a $56.8 million statutory loss after tax after the impairment we reported in the first half of financial year '20 of $242.4 million.

We strengthened our financial position through the equity raising. And pleasingly, we have seen the momentum in sales from March and April carry over into the first 7 weeks of this financial year, which is included in our outlook statement.

Finally, we're very excited about our potential acquisition of a majority stake in Total Tools Holdings and the opportunity that will provide us to further strengthen our hardware business. Brad will provide you some more detail on this acquisition in his section.

I'm going to skip the next slide, the results overview by pillar, as I'll talk about each of the businesses individually.

So on to Slide 7 now, food sales. We gave you the sales update to the end of March when we did the equity raise. So only April has been added now to those numbers to finish out the year. Total food sales increased 3.8% to $7.5 billion for the year. This is up 6.1% if you exclude the impact of Drakes.

Just looking at the chart on the bottom right of this slide, it shows the progress we have been making on our wholesale sales ex tobacco. We continued -- which continued its improving trend in the second half of the year, excluding the Drakes impact plus 0.3% in the first half of financial year '20 to plus 2.5% up until the end of February for the second half. Confirmation that our strategic initiatives are starting to deliver positive results, and then plus 12.3% in the second half when you include the significant uplifts from March and April.

The overall IGA network has performed strongly with like-for-like sales up 5.6% on the year versus a 0.5% decline in FY '19. And pleasingly, we saw market share gains for the IGA network. After several years of closing more stores and openings, we are now into positive store opening numbers, showing the retailers confidence is returning in the brand and our plans. Deflation has been easing, but is slightly offset by the work we continue to do on resetting our pricing and helping to make our retailers more competitive to drive sales. And as called out at our first half results, our team scores increased to 74% this year versus 72% last year.

Convenience sales were higher in the year. While this has been mainly driven by tobacco from larger customers, we did also see an uplift during March and April of our sales into the regional and remote communities service from our convenience business.

Moving on now to Food EBIT. Reported EBIT of $182.7 million does include a $5.2 million positive adjustment for AASB 16. Pre that adjustment, EBIT declined $5.2 million to $177.5 million. On an underlying basis, this would be about $12 million improvement in the year when you account for the reduced provision releases in this year versus last year and the loss of Drakes.

Food EBIT did benefit from the uplifted sales in March and April. However, as we mentioned during the equity raise, we did incur additional cost to deliver that spike in sales, manage the COVID-19 impacts and some of the price investment we've been making to drive sales. We've seen some improvement in our JV earnings, and Scott and his team continue to do a very good job managing their costs, which has helped us once again offset the impact of inflation.

Looking at Slide 9 now. We have tried to call out on this slide, and we've done the same for the other 2 businesses. The changes we have seen since early March and the impact or response from our business. I won't cover all of these, but a few key call outs on Food. We have seen a shift in consumer behavior as a result of COVID-19, most notably the more cooking at home, which you would expect with many of the Cafés and restaurants unable to operate during the crisis and more working from home.

We have also seen a shift to more local and neighborhood shopping, which fits very well with majority of our network. We've listed on the right side -- right-hand side of that slide a few of the results for us from that change in consumer behavior with stores reporting they are seeing more new customers or customers who have not visited for a while and are giving IGA a retry again during this time, with some very positive comments from customers around the changes to the store since their last visit with better prices, ranges, and in particular, hearing those comments from our DSA or refreshed stores, with customers saying they like the store's new look and feel.

The big focus now from Scott and his team and the retailers is to try to hold on to those new customers and retain the market share gains we have seen during COVID-19. The other call out on this slide would be the speed we move to put a network-wide online shopping solution in place, literally achieving in weeks what would normally have taken us years in the past to complete in our processes with the participation of about 700 of our retailers.

Initially, this was only available for the elderly or vulnerable customers to get a box of essential products. We call this a priority shop, but have now moved that online offer on to being available for all customers and a broader range of products. It is by no means perfect as we were operating in a mode of 'good is good enough' during the crisis. And it's still early days, but the momentum with the retailers is building, and we are already discussing with them how we continue to develop and extend this offer.

Moving on now to Slide 10 on the MFuture initiatives. We continue to make good progress on our MFuture plans during the year. Under the store or brand clarity initiative, we have started to apply the learnings out of our small store trial to the rest of the express network and seeing positive results from those changes.

Our first SupaValu of large-format trial store has recently completed its refit and has opened at Doonside here in Sydney. The real focus on this initiative now is on the core IGA-branded store offer, getting our ranges right, store standards, compliance and continuing to work on improving the price competitiveness of our retailers to drive sales.

Under the store network initiative, we've accelerated the number of store refreshes or DSAs we have completed in the year to 124. This now represents about 40% of the network having been refreshed, and we continue to see very good sales growth out of those stores and very positive customer comments, as I previously mentioned.

In Private Label, we launched some additional new ranges in our Community Co products, and these products continue to be very well received by our retailers and their customers.

And finally, under the low-cost operator initiative, our new SA DC is progressing well, and both ourselves and our retailers in SA are looking forward to getting into that new facility before the end of the financial year -- or sorry, end of the year.

Also, pleasingly, we've had some suppliers who had left our shed and gone direct to supplying the retailers have now returned to our warehouse for their distribution, which tells us the improvement work we're doing on being the low-cost operator is working. And as I mentioned earlier, Scott and the team have done another good job on managing to reduce our costs.

If we turn over to Liquor now, total sales in liquor increased 0.3% for the full year to $3.7 billion, the seventh consecutive year of growth. However, the liquor sales were impacted in the last 5 weeks of our financial year, with our New Zealand business being closed due to their level 4 lockdown restrictions and our Australian on-premise business also greatly impacted.

Together, those 2 account for about 20% of our liquor sales. Prior to this shutdown, liquor sales had increased 2.2% in the 10 months to February and improved from -- that had improved from plus 1.7% that we have reported in the first half of this financial year. Through February, we were continuing to see the trend of value growth from premiumization and our on-premise sales were increasing. However, during March and April, we saw consumer behavior change and a shift away from premiumization.

Our retail liquor stores in Australia did experience a short period of panic buying at the end of March, when it was unclear what government restrictions would be implemented and also saw an increase in demand during April following the on-premise shutdown. Like-for-likes in the IBA bannered network increased 3.2% in the year, supported by continued investment into the network. And the percentage of our liquor sales going through the IBA bannered stores remained consistent with last year at 53%.

Moving to Liquor EBIT now. Reported EBIT of $72.8 million does include a $2.2 million positive adjustment from AASB 16. Pre AASB 16 had declined $0.6 million to $70.6 million, impacted by the 5-week shutdown I mentioned and some additional costs we incurred associated with COVID-19. The EBIT margin was maintained at 1.9%.

If we go to Slide 13 now, and similar to Food, look at the changes we have seen in Liquor as a result of the COVID crisis. As I mentioned from a consumer behavior perspective, we have seen a shift away from premiumization to everyday value and a preference for local and convenient shopping, both of which fit our network well.

Similar to Food, Chris and his team quickly put an online shopping solution together with the Shop My Local offer, launching about 6 months ahead of our original plans. Like the online food offer, it's still early days but gaining some momentum with the retailers and customers, and the team have very solid plans in place to continue to develop and improve this offer in the coming months.

Finally, on this slide, a real credit to Chris and the overall Liquor team on -- for how they have responded and assisting our on-premise and New Zealand retailers impacted during this crisis. Many of those customers were put into a very difficult place with the shutdowns. And I know the feedback has been very positive in how they have been treated by the ALM team; again, another great example of living our values.

Looking now at the Liquor MFuture initiatives. Under the digital initiatives, I've mentioned already the excellent work done on getting the Shop My Local marketplace offer up and running 6 months ahead of our schedule. But I would also call out that the team has made good progress with our plans around an integrated POS solution, which is critical to our overall digital plans and also on getting the retailer support for a loyalty program. We've continued our investment into the network, which has been a key sales driver for us and also further expanded our private and exclusive label ranges in the year.

Additionally, we've recently acquired Kollaras Trading, a private label supplier with 75 brands, and Chris will be looking to use this acquisition as an accelerator for growing our Private Label business critical as consumers look for more everyday value. And prior to COVID, we were making good progress in our on-premise initiatives, which has now been impacted with the shutdown, and we'll review this initiative again once we better understand the new norm for that market.

If you turn over to Hardware now, starting with sales. Total sales and Hardware decreased 1.3% for the full year to $2.08 billion, reflecting the lower construction activity during the year and a previously called out customer loss in Queensland. For the 10 months to the end of February, our hardware sales were down 2.8%, which was on an improving trend from the first half of the year, which were down 4.2%.

We did see a significant improvement in sales in March and April, moving our second half sales to plus 1.8%, with strong demand in DIY categories and some forward buying in trade when some of the restrictions that might be put in place were unclear. Retail like-for-likes also increased 1.6% in the second half versus negative 3.2% in the first half, resulting in a full year decline of 0.7%. But as I mentioned at the half year results, we believe a pretty good performance from our hardware business and retailers in a year where the overall construction market was down.

We have seen our sales mix shift as a result of the higher DIY sales from 35% previously to 37%, and our online sales growing very strong, although still from a low base. Pleasingly, Annette and her team have recently signed up 2 new large trade customers, one in Queensland and one in SA, who will both begin to buy from us in financial year '21.

Looking now at the Hardware EBIT. Reported EBIT of $84.2 million includes a $3 million positive adjustment for AASB 16. Pre the adjustment EBIT was in line with last year at $81.2 million with a higher DIY sales mix, another year of very good cost controls and some smaller bolt-on acquisitions, offsetting the sales decline. Total IHG EBIT margins maintained at 3.9%.

Moving now to the next slide on the COVID impacts in Hardware. Starting at the top there with the changes in consumer behavior with the most significant being the uplifts in DIY sales. As I mentioned, along with our hardware retailers seeing many new first-time customers in their stores. Some of those customers commenting, they have passed up our competitors because the car parked were too busy or they had queues outside of their stores, and were visiting the local Mitre 10 or Home Timber & Hardware store for the first time. The hardware team and the retailers are now focused on how to retain those new customers after the crisis who have now had a good shopping experience in their local store.

Moving down. I mentioned the increase in online sales, and we have again stepped up the number of lines available online to about 14,000. And just a final point on this slide is to remember the critical role a lot of our retailers play during a crisis, like COVID or the bushfire, particularly in Hardware and Food and supplying into their local communities. In many cases, they are the only store in the town.

And then finally from me before handing over to Brad to go through the financials. Looking now at the Hardware and future initiatives. The Sapphire Store refresh program continues to be a key program for us in making our hardware network more competitive and driving sales growth with 90 stores having now completed the upgrades, and we are still getting strong interest from the retailers wanting to continue to invest into their businesses.

Under the build trade initiative, we have now completed 19 trade-only stores and are still targeting to get this to 40 by 2022. Our Whole of House strategy has progressed well with additional facilities and alliances in place, and we are now in a very good position to deal with both new housing starts and renovation work.

As I mentioned earlier, it's great to see a couple of new large trade customers joining us and starting to buy from us in financial year '21. And we're very excited about our proposed acquisition of a majority stake in Total Tools Holdings, which will help us to strengthen our trade position and the independent hardware network. Brad will give you more details on that acquisition in a moment.

Under the growing our retail network initiative, we have completed a few more bolt-on acquisitions in our retail network, which now represents 15% of our stores with 40% of our sales. Further progress has also been made on strengthening our digital and trade technology, including additional work on Truck Tracker, Trade Online and Trade Plus. And it's been driving the online channel sales growth with significantly more SKUs available online now and a strong basket average compared to the in-store shopper. And on cost-out, we have now closed our New South Wales hardware DC and opened our new facility in Queensland. From the original HTH acquisition, it's now -- this has taken us from 7 DCs down to 4 achieving significant cost savings, and as you can see on the slide there, our final consolidation is scheduled for the early part of this financial year in WA, bringing us to operating out of 3 DCs. And finally, the hardware team has once again done a great job in managing their overall costs.

With that, I'll now hand over to Brad to cover the financials.

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Brad Soller, Metcash Limited - Group CFO [3]

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Thanks, Jeff, and good morning, everyone. As Jeff said, we've been operating in an unprecedented environment. And I think we can be extremely proud how Metcash has responded to support the independent retailers through this challenging time. It would not be a finance presentation in financial year '20, without referring to AASB 16. I spent a fair bit of time explaining the impacts of this new accounting standard at the half year results, so -- and I'm sure you'll be relieved to hear, I don't intend to do that again. I will, however, give you the very abridged version, which is, it is impossible to compare the year-on-year performance due to the adoption of AASB 16. And for that reason, we have restated the FY '20 results on a pre-AASB 16 basis so you can indeed compare the results to last year.

For those of you who do wish to work through the detail, this information is provided in Appendix II and also in the notes to our accounts.

Moving now to the group profit and loss account. I'll talk to the shaded numbers, which hopefully you can all see, which are the pre-AASB 16 numbers, as I said. Jeff has already spoken to the performance of the pillars, which is a result down to group EBIT of $324 million. I will give you a quick overview of the other key lines in the P&L.

As you can see, depreciation and amortization on a pre-AASB 16 basis is slightly up on last year at $59.4 million. And as we'll see on our cash flow slide, this is also broadly in line with capital expenditure for the year.

Obviously, on a post-AASB 16 basis, depreciation is much higher. Net finance costs at $25.9 million or $3 million lower than last year, with lower interest rates in the period more than offsetting the higher average debt levels.

As with depreciation, finance costs are significantly impacted by AASB 16. The group effective tax rate at 29.2% is in line with the prior period, and you should continue to expect our effective tax rate to be broadly in line with the corporate tax rate.

On a statutory reporting basis, we reported a loss after tax of $56.8 million, which includes significant items of $255 million post tax. The items included in significant -- in the significant line are in line with our guidance to the market and are detailed on the next slide.

We recorded a significant item charge of $255.6 million post tax in the year, most of which relates to the impairment of goodwill and other assets, which was recorded in the first half of the year. In the second half, $3.6 million was incurred in relation to MFuture and the new distribution center in South Australia and a $15.6 million provision was booked as a direct result of COVID-19.

This primarily relates to the provision for losses on receivables for customers whose businesses were severely impacted by government restrictions and the write-off of prepaid commitment for events, which were canceled due to these restrictions. Looking now at the group's cash flow. Once again, I'll do this on a pre-AASB 16 basis. Net cash inflow from operation activities was only $33 million. The key reason for the lower cash generation in the year was a significant increase in working capital in the second half of the financial year.

As you will see on the balance sheet slide, working capital increased from $209 million in the year and is up $155 million versus the half year. Of the $155 million increase in the second half, about $125 million of that is directly related to COVID-19, where we have seen an increase in the debtors balances in the Liquor pillar as well as increase in inventory across all pillars. The non-COVID-19 increase in working capital of about $30 million reflects the acquisition of retail businesses and hardware and further investment in working capital in the Food pillar. The cash conversion ratio after adjusting for COVID-19 impact was $58.7 million -- 58.7%, sorry about that. Additional $125 million investment in COVID-19 working capital should reverse once the pillars start trading in a more normal environment.

Capital expenditure was $61.5 million, which is a $7 million increase in the prior year period. As we continue to invest in growth initiatives, a more significant increase in capital expenditure related to the MFuture program is expected next financial year.

During the year, we spent $29.7 million acquiring businesses, all of which -- almost all of which relates to the Hardware pillar, including a frame and trust operation in South Australia, increasing our ownership interest in G Gay to 100% and acquiring a 50% interest in onerous lease.

There was a net inflow from the sale of business and net loan movements of $9.6 million. In food, the retailers, by and large, continue to fund the DSA investments in their stores themselves without assistance from Metcash. As a result of this and after including the dividends paid in the period and the proceeds of the equity raising, net debt decreased by $122 million versus FY '19. This is reflected on the group balance sheet on the next slide.

The FY '20 balance sheet is post AASB 16, and unlike the profit and loss and cash flow statements, we have not adjusted the prior year comparatives for the impact of AASB 16. However, to assist with the comparison, we have separated lease balances on the face of the balance sheet. Key points to note on the balance sheet are: as called out on the cash flow, we saw a $209 million increase in working capital from the prior year. The decline in tangible asset balances reflect the adjustment to food goodwill booked in the first half of the year. And the balance sheet reflects a year-end cash position of $86.7 million versus a net debt position of $35.5 million at the end of FY '19.

The capital management undertaken in April impacted the year-end balance sheet, and this is explained on the following slide. In light of the significant uncertainty in April, due to COVID-19, steps was taken to strengthen the balance sheet and improve liquidity, and we raised $300 million of equity through an institutional placement with the further $40 million from the share purchase plan being received post year end. We also were able to put in place an additional $180 million of committed short-term debt facilities. The additional financial flexibility has enabled the group to support the retail network during the COVID-19 restrictions as was evidenced by the $125 million investment in working capital as well as invest in growth opportunities.

And in this regard, we have completed on or close to completing on 3 bolt-on acquisition. We have closed a small liquor acquisition in New Zealand and have also agreed terms to acquire the private liquor brands from Kollaras. And we are also in discussion to acquire another large independent retail -- hardware retailer. These 3 acquisitions have a combined cost to us of about $45 million. In addition, we are in wide discussions to acquire Total Tools. The acquisition of Total Tools requires $57 million of capital, and we're also providing them with a $35 million loan facility to support their growth plans. So in all, we expect an outflow in relation to acquisitions of around about $140 million in the first half of FY '21.

The next slide supplies some -- provides some more details with regard to the Total Tools acquisition. As we announced this morning, we have reached the final stage of negotiations to acquire 70% interest in Total Tools for consideration of $57 million. We are very excited by this opportunity. Total Tools is the largest participation -- participant in the professional tools segment in Australia and will sit well alongside Mitre 10 and HTH. The company has 81 stores across Australia with over $0.5 billion in sales. The growth in the store network over the years is impressive, and this is shown in the graph on the bottom right-hand side of the slide.

The acquisition is in line with our hardware strategy, which is to focus on trade customers and Total Tools has a differentiated offering, which is focused on tradies, who require high-quality tools for commercial use. Total Tools has been operating for 30 years and offers a broad range of products, which, as I said, are focused on tradesmen themselves. This is different to Mitre 10, who tends to be more focused on the actual builders.

Total Tools not only supplies the leading tool brands but also has a highly valued and growing own brand offering, and installs pride themselves on offering a broad range and high-quality customer service. There's a strong strategic rationale for the acquisition. The acquisition aligns with Metcash strategy to be the leading supplier to independents in each of its 3 pillars. It enhances Metcash's position in the Australian hardware market, which will benefit the independent retailers in both Total Tools and the independent hardware group. It increases the Hardware pillar's exposure to trade customers. It strengthens both Metcash and Total Tools existing independent networks and will provide Metcash with a more balanced mix of earnings across its operating pillars and will deliver significant value creation opportunities and synergies.

The following slide sets up the key aspects of the agreement we have reached. As I said, Metcash has agreed to buy 70% of TTH for consideration of $57 million. The proposed acquisition is subject to a green binding transaction documentation, which we are now doing under period of exclusivity. The initial transaction just relates to the franchise or company. However, consistent with our strategy in IHG, we intend to have a mix of both company-owned and independent stores across the Total Tools network. And as part of the transaction, we have agreed to provide Total Tools with the $35 million debt facility to fund their growth plans and to acquire an interest in a number of Total Tool stores.

The proposal also has a clear pathway for Metcash to acquire the remaining 30% stake in Total Tool via put and call option arrangements. The proposed acquisition is subject to ACCC approval. I'm sure once we get to the Q&A session, you'll want to ask a lot of questions in relation to the transaction; however, as we're still to sign the final deal, we'll appreciate -- you will appreciate, we'll not be able to provide you with the final specifics of the deal.

I will finish up our presentation by having a quick look at our debt position and the final dividend.

Even on this slide, AASB 16 has an impact, albeit a small impact. And for those of you who have got good memories, our reported debt last year was $43 million, and this has been adjusted down to $35 million as some finance leases have been reallocated. As noted, the group ended the year in a net cash positive position of $86.7 million. As I've advised you before, our debt position is a low -- is at a low point in October and April, reflecting our seasonal cycle such that our average borrowings are higher than what is reflected in the balance sheet, with the average net borrowings in the year being circa $345 million. The debt ratio shown on the right-hand slide have been calculated in a pre AASB 16 basis.

As shown above, the group has a well-balanced maturity profile, and we will be looking to refinance $225 million of debt that matures in August 2021 in the first half of the financial year. The Board has approved a final dividend in line with our current payout ratio guidelines of 60% of underlying earnings. This results in a final dividend of $0.065, which will be fully franked. Our shares will go ex dividend on 7th of July, and the dividend will be paid on the 5th of August.

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 [4]

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Okay. Thanks, Brad. And just turning now to our outlook statements. In the Food pillar sales in the first 7 weeks of FY '21 continued to benefit from a change in consumer behavior, with total Food sales up 9.3% and supermarket wholesale sales ex tobacco, ex the Drakes impact, up 16.7%. The earnings benefit from the increase in sales continues to be marginally offset by higher cost of service, the elevated demand and to manage the health and safety risks.

As previously advised, there will be no sales to Drakes in South Australia in FY '21, and there will be lower sales till 7-Eleven. The business is continuing to progress its growth initiatives focused on further improving the competitiveness of its retailer network and has a strong focus on costs to help offset the impact of inflation and other cost pressures.

In the Liquor pillar, sales for the first 7 weeks of FY '21 increased 5.5% despite customers in New Zealand and the on-premise customers in Australia being impacted by COVID-19 trading restrictions. Trading restrictions were partially lifted in both New Zealand and Australia in May and early June. And all trading restrictions in New Zealand lifted on the 9th of June.

The increase in sales for the first 7 weeks of FY '21, excluding those customers impacted by the trading restrictions, was about 15% up. The business is focused on managing through the changed external environment while also progressing its strategic initiatives, including Private Label and accelerating the rollout of its new Shop My Local online offer across the network.

In the Hardware pillar, sales for the first 7 weeks of FY '21 have increased 9.4%, underpinned by continued strong demand in DIY categories. Weak indicators of future residential construction suggest further weakness in the trade sector is likely from the second half of FY '21. However, the government recently announced stimulus package to boost residential construction and renovation activity is expected to help mitigate this weakness. The business is continuing to progress its growth initiatives in trade, DIY and digital and has a strong focus on costs to help offset the impact of any reduction in sales volumes. There's uncertainty over the timing of further lifting of COVID-19 restrictions in Australia and the extent that our businesses will continue to benefit from the favorable change in consumer behavior.

And with that, we'll now open up to your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Shaun Cousins from JPMorgan.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [2]

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Just a question regarding Food. It looked like Food inflation accelerated -- or pardon me, improved in the second half, given the 0.7% in the full year, and I think you did 0.1% deflation in the first half '20, part of that, I assume, is due to COVID-19 where promotions weren't occurring. Can you talk a little bit about the outlook for food inflation in fiscal '21? And how ongoing strength in sales enhances your position with suppliers and rebates and the like, please?

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

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Yes. I think I can comment and then just maybe pass over to Scott, Shaun. Look, I think there was -- we've said that at the half year results that we were seeing that, particularly in some of the categories that were impacted by the drought. And then you probably saw that was called out even during the crisis in March and April, where, particularly in fresh food, which again, is not a big supply from us to our retailers, it's more a retailers buying that locally. Again, drought impacted, where in fresh food, there was some inflation that was coming through.

But what we had said was, we saw in those categories, so things like pet foods and anything that contained like grains, where -- and rice was another category where there was inflation that was coming through that was mainly drought impacted. But we have tried to call out there that for us, we're offsetting some of what we would normally flow through by some of the work that we continue to do around resetting some of our pricing to help the retailers be more competitive.

So Scott, I don't know if there's anything else you want to add on?

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Scott Marshall, Metcash Limited - CEO of Supermarkets & Convenience [4]

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Yes, just -- so I actually think the key thing in our network is during COVID, in particular, promotions kept going aside from products that were unavailable. We've always talked about our competitiveness in store is working with suppliers to get the prices right. If you think of what we talked about at the half year, I think it's important to call out that you can't benchmark inflation versus the market and how our competitors call it out. We are still resetting prices. And what we have seen is good benefits from that as retail -- as our retailers have been executing the new pricing strategies. Particularly through COVID, we've seen shoppers come in and respond positively to that. So I think it will be a consistent message to the half year for that inflation number, but it is hard to reference versus the market.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [5]

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And improved supplier rebates or relationships just given local seems to be a winning theme right now. You're getting strong growth. Are you getting greater engagement with the supplier community, and hence, the prospect of support and/or rebates?

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Scott Marshall, Metcash Limited - CEO of Supermarkets & Convenience [6]

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I think the right way to answer that is we've had -- since I've started a real focus on partnering with our suppliers, the hard work that the team have done and resetting range and price was already getting great engagement, and you're correct, COVID has absolutely amplified that with suppliers.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [7]

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Great. And my second question is just a little bit around the COVID-19 impairment. Maybe one for you, Brad. Part of it, it seemed to be a write-off of some prepayments or effectively spend that, that couldn't come about, that makes sense. But is there any degree to which you're writing-off receivables of customers that you don't believe will be around or is there a degree of debt forgiveness in that impairment? I'm just curious, particularly around your customers. And do you think you will unfortunately maybe lose some of those during this period? Or is it more of a debt forgiveness issue, please?

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Brad Soller, Metcash Limited - Group CFO [8]

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Yes. So in terms of the write-down, there's 2 components. The biggest component, as you said, Shaun, is us actually taking a prudent position in terms of the actual debts that are owned to us, predominantly from our customers in the Liquor pillar, which has saw their businesses actually severely impacted by the restrictions. So 20% of those customers actually -- of our sales are to those customers, and we did actually take a provision against those customers.

We also actually took a provision against where we had prepaid certain events. It was a smaller component of that provision, where it's unlikely those events are actually going to go ahead. So we've actually booked a provision in relation to that.

We have not taken any direct operating costs in terms of a significant item. The only adjustment -- the only component that we put into significant items is the write-off of assets.

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Shaun Robert Cousins, JP Morgan Chase & Co, Research Division - Senior Analyst [9]

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And so with that Liquor pillar, in terms of -- are you concerned there that those customers won't be able to pay? And pardon me -- sorry, excuse me, pardon me, won't be able to be around in the future there? Or is that just a degree of debt forgiveness -- or sorry, excuse me, not debt forgiveness, but effectively forgiveness of the obligation they have to in terms of debt...?

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Brad Soller, Metcash Limited - Group CFO [10]

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So we have not forgiven any debts due to us. We've put a lot of those customers on actual payment plans, and we're actually seeing those payments starting to flow, albeit at a very much slower rate. They are continuing to pay us. But on the accounting standards, we actually are required to actually take a prudent view, and we've actually made a provision against a number of those outstanding balances. But to date, most of them are actually paying us, albeit at a much slower rate.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [11]

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Yes. It's just -- I think there's still just a lot of uncertainty around that, Shaun. So we're just trying to get ourselves into a prudent position. As Brad said, hopefully, we'll do better than what we put in there. And if we do them, we'll certainly return it back.

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Operator [12]

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Our next question comes from Grant Saligari from Crédit Suisse.

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Grant Saligari, Crédit Suisse AG, Research Division - Head of the Consumer Staples, Discretionary Retail & Agriculture and Director [13]

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So I guess my first question is, it looks like you may have made some improvements in terms of cost efficiency, trying to normalize some of those peak costs that you have over the last couple of months. I'm wondering whether you could elaborate on that? Because if I look at the second half number for Food, adding back the onerous lease mitigation changes, it looks like the EBIT was up 8% or 9%, maybe 10%, and you would normally get that with 4% or 5% sales rise. So you didn't actually make any money out of the sort of peak sales that you had, and we sort of understood that. But when we look at your outlook statement, you're now saying that, that additional sales growth is marginally mitigated by costs. So I'm just curious about how those costs have moved? And whether you've been able to move to a more efficient platform in terms of costs?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [14]

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So no, Grant, we did make more money out of those additional sales. But Brad, do you want to?

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Brad Soller, Metcash Limited - Group CFO [15]

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Yes, sure. So just, Grant, in terms of those sales, we estimated those additional sales related to COVID-19 were about $250 million. What we've actually said in relation to those incremental sales, usually, in terms of the models that most of the analysts put through, you have a range of incremental earnings dropping through from that sales, so call it, somewhere between 6% and 8%. What we tried to steer you to is that during the peak of the COVID crisis, we were being impacted by incremental costs, and we call those costs out and say, call it, 200 basis points, so the additional sales of $250 million were coming through at something like 200 basis points lower incremental margins than we would expect. And the reason for that is, one, we're working longer shifts. So we're actually into night shifts and some of those shifts we're operating 24x7, which resulted in penalty rates being paid in relation to the shifts. We also took some time to actually get used to how to actually operate in a more restricted environment. We invested more in protective gear and health and safety operations.

Going forward, in terms of any sales uplift that's actually coming through, we think that we were unlikely to actually still have that negative headwind that I called out of a 200 basis points because as the shifts can cope with an incremental sales of 15%, 20% probably within its existing capacity, but I'll let Scotty expand on that. So going forward, I don't think the headwind will be as high as the 200 basis points we flagged impacting the final 2 months.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [16]

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Yes. The things that remain in place is that we've had to keep the same working practices in the DCs to keep our teams safe there. So that restricts us a little bit. But we're certainly not working those premium shifts like we were before. So I don't know, Scott, is there anything you want to add?

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Scott Marshall, Metcash Limited - CEO of Supermarkets & Convenience [17]

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Yes. Just to add to that and give some context, if you go back to mid-March when the panic buying happened, we effectively stood up a whole new distribution center within 2 weeks. So there's obviously costs around that. If you move forward, now we've got consistent volumes. And look at our history here, we're good at distribution and good at been a low-cost operator. So like Brad pointed out, we have absolutely got control moving forward. So we're quite positive that as we get those increased sales, we'll benefit and pass it through and our retailers will benefit as well.

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Grant Saligari, Crédit Suisse AG, Research Division - Head of the Consumer Staples, Discretionary Retail & Agriculture and Director [18]

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All right. That's really helpful. If I could just ask a second question, if I could? The retailers in Food obviously have done really well. They have got some positive market share shifts that's apparent in the data. Are you seeing that translate into any grade or willingness to invest on the part of the independent retailers? Or do they as well just see this is temporary? So for example, any increased demand for DSAs? Is there any increased anecdotes around reinvestment by the independent food retailers?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [19]

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Yes. Good question, Grant. I think what we are seeing is the retailers were all very positive in the back half of last year. They are all seeing the hard work starting to pay off. That was amplified through COVID. And I think the retailers that had invested in their stores and were resetting really got the most benefit. On the back of that, we're seeing a lot of interest for those retailers that are further down on the list of DSAs to want to go and fix their stores. So I'm quite confident moving forward that we'll get a lot more interest in that space.

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Grant Saligari, Crédit Suisse AG, Research Division - Head of the Consumer Staples, Discretionary Retail & Agriculture and Director [20]

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And just quickly, Brad, it sounds like from your comments that the working capital hasn't normalized yet, but would do so once sales level of that maybe just clarify whether the working capital is starting to normalize?

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Brad Soller, Metcash Limited - Group CFO [21]

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So, no. So we're still actually running with elevated working capital. We went through to determine how much is COVID related, and we quantified that number at $125 million. So we have seen our debtors build up particularly in the Liquor business. Some of that's actually started to come down, some of them want a payment plan. So it will take some time for it to actually reverse. We expect, as Scotty gets more stability, in terms of the volumes come, and we have more -- we can predict with greater accuracy the volumes, we'll see some better outcomes in the logistics operations and the inventory levels.

So the expectation is over time is that we would actually get that $125 million -- some of -- most of it will actually reverse over time. But obviously, anything that is not collected under the COVID-19 balance is anything that goes into defaults will impact those negatively.

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Operator [22]

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Our next question comes from Andrew McLennan from Goldman Sachs.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [23]

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Good morning, everyone. Just I want to follow-on with the question on the DSA stores. You've reflected in your presentation that they continue to do reasonably well, 15% sales uplift on the investment programs. I'm just wondering, though, in terms of the relative performance, if you could explain how a DSA-upgraded store performed during COVID versus the older formats? I mean from the feedback I've been getting from some of your customers, the relativity has been be notable, but there's been strength across the board, but there has been a relativity. I'm just wondering if you could sort of talk to the relative performance between those formats, please?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [24]

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You want to pick that up, Scott?

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Scott Marshall, Metcash Limited - CEO of Supermarkets & Convenience [25]

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Yes. Thanks, Andrew. I think, as I said before, I mean we still have to drill into it because we are seeing a lot of increased volume still happening in the market. So I don't have a full analysis on a DSA versus non-DSA, but what we saw are a consistent uplift everywhere. But those fresher stores that we're executing, the range and price, definitely traded very strongly and saw a lot of new customers in their stores. And through the feedback we get through our customer surveys, there was some very pleased customers. And our -- what we're seeing so far is that the new customers are being sticky and coming back to those stores because they've been pleasantly surprised by not just the experience, the range, but also the price competitiveness of those stores.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [26]

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And the price investment you talk about, there was a comment, I think, in the presentation or the reports saying that this is mostly due to the increased sort of volume rebates. Was there a deliberate decision to invest in price leading into this? I think you had spoken of one.

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Scott Marshall, Metcash Limited - CEO of Supermarkets & Convenience [27]

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Yes. Look, I think there's a whole combination there of -- some of that's us working with the suppliers, some of it is just us, which could be a timing difference of getting the retailers into a more competitive position. But on the volume rebates, that works by tiers, tiered structure. So as the retailer sales would be going up, then we would tip into higher levels of rebates that are going back to them.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [28]

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Okay. But the price investment you spoke of, part of it was just a function of that significant lift in volume, but how much was deliberate?

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Scott Marshall, Metcash Limited - CEO of Supermarkets & Convenience [29]

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It wouldn't have been that material. And the majority of that is coming from the suppliers.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [30]

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And Andrew, it was planned. Obviously, the first few weeks of COVID with the panic buying, with promotions in place, there was a small incremental impact there. But we worked very closely with suppliers, and that's very planned through the ongoing promotions.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [31]

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Yes, sure. Okay. Now just from a hardware perspective, you already had a very strong position in trade. I'm just wondering how the business looks now with Total Tools and a few more acquisitions and a couple more commercial customers out of -- I guess, my question is how are you feeling strategically about this business, its competitive position in the market?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [32]

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No, we think very strongly. Obviously, we think Total Tools complements the overall network. It helps us strengthen our #2 position in the market. We are more of a trade-based business than a DIY-based business. So as a result of that, Total Tools fits in quite well. For us, those professional tool categories are not a big part of our sales currently. So the opportunity there is for us to strengthen the overall network on the professional tool side. So I don't know Annette, is there anything you'd want to add on?

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Annette Welsh, Metcash Limited - CEO of Independent Hardware Group [33]

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I think the only other thing to add, Andrew, is that we've always been -- it's always been important to us to have a balance in the portfolio. So we've always had that split of DIY building small-to-medium builders, multi-residential and also the renovations market, and the Total Tools business just helps add to that balance in the portfolio.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [34]

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And Annette, do you think that given the increase in scale that you're delivering here with these transactions will now enable you to further consolidate the market? How much more is there to be done?

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Brad Soller, Metcash Limited - Group CFO [35]

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It's still a very fragmented market. We've called that out before. And yes, so certainly, there still is opportunities going forward.

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Scott Marshall, Metcash Limited - CEO of Supermarkets & Convenience [36]

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So if you look at, in terms of the capital we've actually deployed in the last year, we have identified some fantastic opportunities in the Hardware business. And we have given, Mark and Annette the capital to actually do it, which includes both investing in their store network, so increasing ownership of some of the JVs to 100%, investing in their ability to actually fulfill that whole of our strategy as well. And I think Total Tools is a fantastic acquisition for us to actually have been able to close on. It is achieved at -- we think we -- like -- we've shown a disciplined approach to actually buying businesses within the Hardware business, and I think we have a track record of buying well and Annette and her team of executing well. So I think there is a -- we're looking forward to very positive results once we close the Total Tools acquisition.

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Andrew J. McLennan, Goldman Sachs Group Inc., Research Division - Consumer and Retail Analyst [37]

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Yes, Brad, just on it. You were the underbidder originally on that asset, I do believe from what's in the press. Did you have to change -- obviously, the winning bidder walked away. Did you have to change your pricing expectations as a result of that experience?

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Brad Soller, Metcash Limited - Group CFO [38]

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We are very disciplined in how we actually buy -- carry out acquisitions, Andrew, as you can well imagine. We think we've bought this business at a reasonable value. We think we bought it at a value that reflects current market conditions.

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Operator [39]

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Our next question comes from Ross Curran from Macquarie.

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Ross Curran, Macquarie Research - Analyst [40]

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I was just wondering, I know it's been an exceptionally volatile period, but maybe if you could help us understand how the last 2 or 3 weeks has gone relative to the last 7 weeks of trading? Have consumers started shifting behavior as restrictions have started to be eased?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [41]

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The last couple of weeks have been very consistent with the previous 5. So it's been, as we said, across that period of time, it's been fairly consistent.

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Ross Curran, Macquarie Research - Analyst [42]

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Excellent. Secondly, just can you help us understand the decision to close the DC in Hardware in New South Wales? It seems like quite a big geographic location for service without having a DC here. What does that mean for service costs for the Hardware business?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [43]

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No, that all worked out very, very well. That was always the plan. The plan was always to go from 7 to 3. New South Wales can easily be serviced out of Queensland or Victoria. We are talking about the sort of lower turnover-type goods. So it's not stuff like fresh food, where you've got to get it there in 12 hours or something.

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Ross Curran, Macquarie Research - Analyst [44]

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And then finally, just -- the press are just talking about, and I know you won't talk about specific M&A, but maybe if you could help us understand your M&A philosophy. Would you be interested in vertical integration or acquiring manufacturers in that hardware space?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [45]

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Yes. Well, look, nothing has changed as far as we're willing to listen. And if we find acquisitions that help us to accelerate our plans, like some of them that we've called out today, and we can deliver those on the right values, then certainly, we're interested.

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Operator [46]

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Our next question comes from Richard Barwick from CLSA.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [47]

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I just wanted to ask, firstly, just trying to think about all the moving parts in Food earnings as we head into FY '21, I just want to make sure we sort of touch off the different elements, if you don't mind? So obviously, we've got the annualization of Drakes, we've got the 7-Eleven impact, but then it's the little less clear, should we be expecting any further movement in onerous lease contributions impacting FY '21?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [48]

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Do you want to take that, Brad?

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Brad Soller, Metcash Limited - Group CFO [49]

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Yes. So just I'll answer the onerous lease provision. So what we actually had -- the number is gradually getting smaller. So if you recall, in FY '19, it was about $18 million; in FY '20, it's $10 million. The actual balance provision for onerous leases itself is actually getting smaller. So our view is that it will be significantly lower than it actually was in FY '20.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [50]

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And this second half was virtually nothing wasn't it?

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Brad Soller, Metcash Limited - Group CFO [51]

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If you work out in terms of the second half what we actually had, it was around about $4 million.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [52]

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$4 million?

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Brad Soller, Metcash Limited - Group CFO [53]

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Yes.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [54]

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Yes. Okay. And so -- but so something smaller than that would be possible into FY '21. And then also just to clarify the way you were talking, Brad, if we've got this sort of extended or if we do have a period of elevated sales growth, you're saying with now the absence or the normalization of the incremental costs, a 6% to 8% EBIT margin on the elevated sales is the right way to think about it?

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Brad Soller, Metcash Limited - Group CFO [55]

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I've just quoted back the range that I hear from you guys. So I think it's a reasonable range to actually be adopting, but it is the range you guys actually apply, and we haven't corrected it, so we must think it's reasonable.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [56]

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Okay. Good. And then finally, I mean, are there any other continuing costs we need to be thinking about, particularly relating to COVID or anything else for that matter?

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Brad Soller, Metcash Limited - Group CFO [57]

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I think -- and I'll let Scotty answer, I'll jump in first. I think what's actually happened is, as Scott said, is when we actually had these peaks and real spikes, we weren't really prepared for it. And we actually had to actually get -- we incurred additional costs. There were also some learnings in terms of how we actually operated under COVID-19 restrictions. I think we are getting better and we're getting used to it. So we should be able to actually deal with those costs and those volume changes. There are some other cost pressures that are actually coming through our business, which we should be aware of. One of them is the insurances. I'm sure you've spoken to many other companies. One of the key cost increase coming through our cost base is the cost of insurance, both D&O and all risk policies have actually gone up quite significantly, and that will be reflected in the current year's numbers. But Scotty, do you want to talk about the...?

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Scott Marshall, Metcash Limited - CEO of Supermarkets & Convenience [58]

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Yes. No, I think it is important to call out. We asked with the increased volumes, we are working some premium hours. We're working very hard with suppliers to still close some gaps in the range. So there's still roughly a dozen categories where full supply is not available, although we do have a product in every category. So what has happened here, most suppliers have rationalized their ranges and -- to ensure they can have product on the shelf. So we still have some further sales upside there going forward, which we think will offset those costs as well.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [59]

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Okay. Just a couple of things to clarify there. I mean from what you're saying, Scott, you're saying you are running elevated hours, but then from the message earlier was that the sort of work through the peak or the peak volumes and sort of roll that into the normal course of business -- or if I got that wrong, I mean is the previous comment rating to the extreme sales uplift in March?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [60]

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Yes. No, it's related to that because -- I mean, to do the volumes that we're doing, there is additional labor costs that go into doing that, but it wouldn't be above the normal sort of margins that Brad's talking about. The impact that's still there is that we still have to operate our DCs using these COVID-safe work practices. And that does hurt us a little bit in some of the ways that we have to work and that does cause us to incur a little bit of extra cost. That's mainly what we were calling out.

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Richard Barwick, CLSA Limited, Research Division - Research Analyst [61]

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And then the last one, just a little bit more on Total Tools. I take it from the way you've talked about it, are all stores franchised currently? And then, can you give us a bit of a sense of the shape of the stores? So what's the number of stores per franchisee, for instance, do they have a couple of really big franchisees or it tends to be quite frankly...?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [62]

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There's one corporate store and 80 of them are franchisees. But I don't know, Brad or Annette, you want to just comment?

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Brad Soller, Metcash Limited - Group CFO [63]

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So there's not -- there are a couple of owners that have a few store. I think the biggest store owner net is 7 stores. So there aren't -- most of them are franchisees that have one store, possibly 2. So we don't have the situation as we actually have within the Food with some of the big MSOs in operation.

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Operator [64]

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Our next question comes from David Errington from Bank of America.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [65]

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Brad, this question is to you. I'm trying to understand the really big increase in inventory? It's nearly $300 million, and I've looked in the last 3 years, your average inventory is around $750 million. I'm just trying to work out. I know there's COVID and all the risk, but why was there such a big increase in inventory that's absolutely poleaxed your free cash or your cash realization? And you said that it hasn't normalized yet. I'm just wondering why are you holding so much increase in inventory in your sheds?

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Brad Soller, Metcash Limited - Group CFO [66]

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So some of the -- the increase in inventory -- a lot of the increase in inventory has actually to do with the higher volumes that we actually are selling anyway. So if you look at the volume during the last 2 months, the last 2 weeks, that is actually greater. So we actually do need to actually carry more stock and even if we're actually having the same number of days in stock on hand. So that's part of the actual increase, Dave. The other one is, I think Scotty will actually say is, given the uncertainty that we actually had in terms of supply chain, there's no doubt we've actually jumped up the number of days -- the number of weeks stock we're carrying. So we took a more cautious position in terms of the actual inventory we actually had. That was across all pillars. So that's also the case that we actually have within the hardware pillar where we actually bought some stock just to make sure we had some adequate coverage. And the good thing about that increase is -- a lot of that increase has been -- we haven't seen the full impact of that increase in the inventory flowing through our working capital. Some of it actually has been funded by our creditors, not all of it, because we took the deliberate decision to actually increase some of the days that we actually had in inventory to give us more cover.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [67]

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Yes, it's just a big jump, Brad. I mean you're talking $300 million. I mean it's a big jump. I'm just wondering how the sheds could even handle that level of increase in inventory? What would -- how long is it going to be like at this level for?

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Brad Soller, Metcash Limited - Group CFO [68]

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It's -- I don't know. In terms of actually -- once we actually see sales coming back to a more predictable rate, and then we actually certain -- we have greater certainty as to the supply chain and the certainty as to deliveries plus we actually have greater certainty as demand from our retailers, I guess we can get to the position that we can actually adjust those inventory levels back down again.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [69]

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I thought, Brad, that I mean all the other retailers have been saying it's normalized for at least a month. I mean, certainly, my observation being a shopper, I would have thought things normalized around about mid-May, end of May. So I'm surprised you're still saying it's still uncertain at the moment. Most people -- I mean, Brad Banducci and these guys and Steve, they are all saying things are pretty much normalized in that area.

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Scott Marshall, Metcash Limited - CEO of Supermarkets & Convenience [70]

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David, it's Scott. I'm happy just to -- we're in the outlook statement. I mean, we've called out that with the increased sales that we've had, and Jeff has indicated that that's rolled forward. So we're definitely seeing some new shoppers in our stores and increased sales on the back of that means that retailers out there are doing a really good job. We have definitely still got some increased volumes in our sheds in some categories because we're still replenishing the supply chain in some aspects. As you know, there's a lot of restrictions on product, et cetera. And a lot of empty slots on shelves. So as they are getting replenished, we're seeing more and more sales on the back of that.

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Brad Soller, Metcash Limited - Group CFO [71]

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And Dave, just to bear in mind, obviously, that's the number at the end of April, not the number now.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [72]

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What's the number now?

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Brad Soller, Metcash Limited - Group CFO [73]

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Oh, we're not going to give you that number now, mate.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [74]

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But have you got stock there that's taking -- like, you are overloaded with stock that's slow-moving or is it fast-moving stock?

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

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So David, we're really clear how we operate on the weak stock turn and certainly not sitting on slow-moving lines. And I think from when I came in, the focus was to get the right range in the shed. That has seen help us grow that teamwork score with retailers as well. And we've got new suppliers coming -- old suppliers coming back into the network as well, which changes that number slightly. So the total sum of that number in April was a combination of all those things. So it's a range more suited to the stores, which grew the teamwork score, it was some suppliers coming back into the network and it was those increased sales. But I can assure you, we're very focused on getting the right mix of stock in the warehouses.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [76]

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Okay. So what you're saying is nothing to worry about; it will normalize. Is that what you're saying, Brad, can you put your name to that?

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Brad Soller, Metcash Limited - Group CFO [77]

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In terms of -- I'm looking at my esteemed colleagues around the table, they are actually buy the stock. And in terms of our intention is to actually drive that working capital back down to normal levels on once we actually have some stability in both the supply chain and the demand from our customers.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [78]

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Okay. Brad, why only 70% of Total Tools and what's this $35 million that you've guaranteed them? Can you elaborate on that?

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Brad Soller, Metcash Limited - Group CFO [79]

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Yes. So there's 2 things. So there is a clear pathway, David, to actually get to 100%. So we have put in place a series of put and call arrangements that enables us to actually get to the 100% within roughly a 3-year period. So that's -- we will eventually own 100%. And then the other component in terms of the loan facility we intend to provide them is, we do want to acquire some of their franchisee stores and take our ownership interest. It's very similar strategy to what we've successfully done in the hardware pillar at the moment through a combination of independent and company-owned stores. So we will look to actually acquire those stores going forward in that facility specifically for that purpose.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [80]

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But you're lending money to yourself really aren't you, so the real acquisition for us is above $90 million. Is that right? And plus, you've got to buy another 30%.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [81]

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That's correct. So our overall commitment is, if you add the 2 together, we are buying those stores for the 70%, we'll pay the 57% (sic) [$57 million] plus, we'll actually give that facility to buy stores and fund whatever CapEx and growth they actually need to do. And then in 3 years' time, we'll look to acquire the remaining 30%. So what multiple are you paying, Brad?

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Brad Soller, Metcash Limited - Group CFO [82]

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I knew that I was going to get -- asked this question. It's -- we can't -- until we actually close the deal, Dave, we can't really actually say -- it wouldn't be fair on Total Tools for us to actually disclose that. But we think we've actually bought it at a reasonable valuation, taking into account current market conditions.

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David Errington, BofA Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia [83]

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What does that mean, Brad?

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Brad Soller, Metcash Limited - Group CFO [84]

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A reasonable multiple.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [85]

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It's a good deal.

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Operator [86]

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Our next question comes from Bryan Raymond from Citi.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [87]

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Just to follow-up on Total Tools. My first question is just around the potential synergies there. I imagine buying is probably where you'd find the majority of those synergies. But given you mentioned earlier that the professional tools segment is not a big part of your existing Mitre 10, Home Timber & Hardware business. How should we think about that magnitude of synergies, maybe in the context of the Home Timber & Hardware acquisition and the synergies you generate out? That would have been materially smaller than that or is that a good guide to use?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [88]

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No. I think the Home Timber & Hardware synergies were extraordinary. So if we track those, they were north of $30 million. The businesses were actually very closely aligned in terms of their products they actually sold, in terms of their back office, in terms of how they actually operated, where we actually look at the tools category and most of the lines that are within Total Tools. We don't have a very strong presence in the tools category, so we won't get those huge merchandising synergies. And it is intended that we actually run the front part of those operations as a independent business. So Paul Dumbrell, he, currently is the CEO of that business, will continue to actually drive the sales and drive the relationship with the franchisees.

And the other big synergy there actually came out of the Hardware space with the HTH acquisition was the consolidation of their sheds and their DCs that drove a significant amount of savings. They don't have a DC operation in Total Tools. So but think we get some efficiency in getting inventory into their stores more effectively, but you won't get that huge step-up in cost savings.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [89]

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Right. Okay.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [90]

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When we've are finished with the deal, Bryan, we should be able to give you a bit more information around that. But as Brad said, it wouldn't be anything compared to like the HTH because this is a very different business.

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Scott Marshall, Metcash Limited - CEO of Supermarkets & Convenience [91]

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But there are synergies. I don't want anyone to walk and not think that we're going to deliver synergies from this transaction. There are definitely synergies. I just don't want anyone to think it's the quantum that we actually did in relation to the HTH transaction.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [92]

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No, that's fine. Just sticking with Hardware for a moment. I noticed you'd acquired 6 businesses or 17 stores, could you try and help us understand the earnings contribution from that, given you had a flat overall earnings result? I'm just trying to work out an organic profile for hardware.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [93]

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So those would have been phased in at different times throughout the year, Bryan. And in fact, the one lease one came in right at the very end of the financial year, but I think it was around $3 million or something in the year, wasn't it Brad?

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Brad Soller, Metcash Limited - Group CFO [94]

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That's right. Yes, total.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [95]

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Yes. It's about $3 million. Yes, $3 million total in the year.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [96]

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Okay. Great. And just on the Food business, just again, point of clarification. In terms of those COVID-related costs, Brad, I think you called out 200 basis points of the $250 million of additional sales, which is about $5 million. And then separately in the presentation, you talk about the 20 basis points margin decline being driven by -- for the full year being driven by these costs with COVID, which is about $18 million. So I just wanted to get a feel in dollars of what that is on like a monthly run rate and then sort of how that's progressed in the last couple of months, if that's winding back at all?

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Brad Soller, Metcash Limited - Group CFO [97]

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I think you're looking at 2 separate numbers. I think in terms of the actual incremental cost in the COVID, I think that still we gave you in terms of that number is right. And I think you've got roughly the right number, Bryan. If you look at it, the other one is a 12-month trading period, and there's a whole lot of things that actually impact on that. It's both the loss of Drakes. It's -- everything is flowing through that number over there. So you can't really compare the 2.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [98]

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Right. So the first one I went through, the $5 million or so over 2 months is probably the right way to think about the run rate?

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Brad Soller, Metcash Limited - Group CFO [99]

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It's the right number in terms of the actual impact that it has actually had during those 2 months because of trading. As Scotty said, hopefully, we won't have that magnitude of impact going into the FY '21 year.

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Bryan Raymond, Citigroup Inc, Research Division - VP & Analyst [100]

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Okay. Okay, great. And then just finally for me, just on Liquor, interesting acquisition of the Private Label business. Could you just remind us what your Private Label mix is currently? And where you think you can get it to post Kollaras coming into the portfolio?

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

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Yes. Chris? Yes, Chris has been sitting out there by himself. So let's get Chris involved.

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Christopher William Baddock, Metcash Limited - CEO of Australian Liquor Marketers [102]

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Thank you, Bryan. So our Private Label business penetration is single digit. And you will see that other retailers announced that it's in the teens. So my view would be that we'd be moving into double-digit over the next couple of years.

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Operator [103]

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Our next question comes from Michael Simotas from Jefferies.

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Michael Simotas, Jefferies LLC, Research Division - Equity Analyst [104]

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First one from me is on Total Tools. And just in terms of the franchise structure, that's a little bit different to the other businesses you currently have. Can you give us some sense of what the economics of that business would be like? Should we just use your margin in Hardware as a starting point? Or would it be materially different because it is franchised? And related to that, are all of the franchisees profitable? Or is the intention to buy out some of the franchisees resulting from the fact that their businesses aren't currently profitable?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [105]

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So in terms of the answer to the second point, they have a very healthy network of stores. And obviously, through the due diligence process, we actually had a look at the profitability of the network. So overall, we are very comfortable that the network is in a healthy state. In terms of the overall profitability of Total Tools and what we'll actually get relative to Metcash's performance, we'll probably better wait until we actually get to announcing that close -- at the deals closure. It wouldn't be fair for me to actually put numbers out in the public domain on Total Tools' performance until we actually had reached financial close.

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Michael Simotas, Jefferies LLC, Research Division - Equity Analyst [106]

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Okay. And then just a couple of other sort of data questions and apologies upfront. You mentioned associate earnings were a bigger contribution in FY '20 relative to FY '19. They're actually lower in the second half than in the second half '19. And I would have thought that second half period would be a very profitable period for your food joint ventures and associate investments. I know there are differences in balance dates. So can you just sort of talk us through what happened there?

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Brad Soller, Metcash Limited - Group CFO [107]

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Yes. Sure. I love these detailed questions in terms of the cancel. I think the biggest difference would be that we actually moved some of those from associates into a wholly-owned subsidiary. So Gay, we moved out of associate lines to actually become a consolidated entity. And also, you wouldn't be able to give an explanation without referring to AASB 16. So we did have some chewing up of the AASB 16 results as we got more information from those associates in the second half of the financial year.

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Michael Simotas, Jefferies LLC, Research Division - Equity Analyst [108]

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Okay. And since you like that one, I've got another accounting question. If I look at the expense note in the accounts, you've got an impairment of trade receivables and loans that's about $13 million. It was $5 million in FY '19. So that's a drag. But we can't tell what amount of that is above the line and what amount is below the line in your significant item. Can you give us some color, please, around what the underlying impact of impairment of trade receivables and loans was?

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Brad Soller, Metcash Limited - Group CFO [109]

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So in terms of that impairment, the actual number that we actually showed you in that number $13.2 million, that's actually all above the line. So that's the entire charge that we actually took. And if we actually look at what we took below the line, it was $15.6 million, but that actually includes some event cancellations, but most of that, roughly $3 million related events. The other $12.6 million are related to impairments of debtor balances, and that was the bit that was taken below the line.

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Michael Simotas, Jefferies LLC, Research Division - Equity Analyst [110]

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Okay. So the way I should think of it is you had effectively an $8 million drag above the line in your underlying EBIT from provisions on receivables volume?

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Brad Soller, Metcash Limited - Group CFO [111]

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Yes. And I think if you look at -- you're absolutely right. But if you look at our average bad debt impairments over the last 5 years, it's been relatively low.

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Michael Simotas, Jefferies LLC, Research Division - Equity Analyst [112]

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Yes. I mean it's a bit higher in '20, which is not surprising, I suppose.

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Operator [113]

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Our final question comes from Phil Kimber from Evans & Partners.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [114]

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I just wanted to clarify when you talk about underlying the food business benefited by about $12 million. So I mean, is the rough calculation you're doing there going back to '19 and adding back roughly $20 million for Drakes EBIT and then I think you probably got half of that in the FY '20 year? And then the onerous leases sounded like they have gone from roughly $20 million to $10 million. So have you adjusted both -- I just want to double check to make sure you're adjusting both years for the onerous lease and Drake. So the net impacts $12 million? That was my question.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [115]

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Yes. Yes, that's correct.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [116]

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Okay. So I mean, that looks like your second half EBIT in Food is up like 14% or thereabouts, which you're saying obviously COVID helped, not as much as maybe it's helping now because you had some upfront additional cost because everything was going so crazy. But have I missed something in my analysis, as you already on an underlying basis is up in the teens in the second half of FY '20 for Food when you adjust out Drakes and the onerous lease issue?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [117]

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Yes. No, that's correct.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [118]

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Okay. So is there any reason why that's -- why should we think that underlying number? Obviously, we know that there's another roughly $10 million to come out in FY '21 from Drakes and what is it? 9 months of 7-Eleven, is there any reason why that underlying number is going to change dramatically? How should we be thinking about that? I mean, it seems like you're still benefiting probably even more so now for COVID?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [119]

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Other than calling out where we're at on the sales, we're not going to provide any further sort of guidance on earnings. But as we said, we've seen the sales carry over, and we've seen those spikes that we had in cost in March and April come down to more normalized sort of levels now.

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Phillip Kimber, Evans & Partners Pty. Ltd., Research Division - Executive Director of Consumer [120]

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Okay. That sounds positive. So then -- and my last question is just around any update on 7-Eleven on keeping -- I think you're thinking you might be able to keep the DIY business. And then just on Food works, has there been any changes there because I think that contract comes up? Or it's at its normal rolling stage. So any comments you can make on those 2 customers that would be great?

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [121]

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So 7-Eleven, we said at the time, at the half year results, that we were still in discussions with them about a smaller part of still supplying to them, and that would include the supply to them in WA and also the supply of what they call the tail of their products. And we're at the very final end of negotiations on still continuing to do those 2 businesses for them. So on the East Coast, it would be that tail. On the West Coast, it would be the full supply to them.

As far as food works at, it's still in the same place, which it's a rolling 12-month contract. We've had very good relations with them all the way through this crisis. I know they felt like they have been taking care of very well. I don't know, Scott, anything you want to -- we've had to put some of our conversations on hold with them just because of the crisis going on now, but anything you want to say on the relationship?

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Scott Marshall, Metcash Limited - CEO of Supermarkets & Convenience [122]

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No, I think you've answered that well, Jeff, that we are working closely with them and their retailers have also benefited from increased sales through the period, and we've worked very closely with them in replenishing their stores and helping wherever we can.

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Jeffery K. Adams, Metcash Limited - Group CEO & Executive Director [123]

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All right. Well, look, thanks, everybody, for joining this morning. And look forward, I know we'll catch up with the majority of you over the next 2 or 3 days. Thanks.