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Investors like stocks that own great slabs of the market because in investing parlance they own moats. Like the water that protects the castle, these companies manage to hive off a substantial piece of the market for themselves – by virtue of their intellectual property, capital, or network. Although there are plenty of stocks in Australia that enjoy the luxury of moats, this week we’re investigating grocery distributor Metcash and private hospital provider Ramsay Healthcare.

New moat for Metcash (MTS)


Chart: Share price over the year to 18/11/2011 versus ASX200 (XJO)

Investors in Metcash have seen their shares grind up and down the charts over the past two years; the stock has dropped some 11% over two years, and is down 5% over the past 12 months. Share price performance has not been reflective of Metcash’s growing moat, however – a moat that has become so large that the ACCC has tried to intervene to stop the retailer, without success.

Metcash, currently headed by South African CEO Andrew Reitzer bought the Franklins chain of supermarkets from South Africa-based Pick n Pay Holdings at the end of September this year for roughly $215 million. The acquisition is estimated to deliver $500 million in wholesale sales per year (and if that’s indeed the case, Franklins was purchased for an absolute steal). Metcash also owns the IGA grocery store banner.

The Australian Competition & Consumer Commission (ACCC) sought to prevent Metcash’s acquisition of Franklins. A statutory authority, the ACCC’s role is to enhance the welfare of Australians through the promotion of competition. In the case of Metcash, the ACCC argued that the acquisition of Franklin’s would lessen competition in the wholesale food market. The case comes at a sensitive time for Australians already burdened with escalating living costs. According to a Daily Telegraph survey, 60% of people spend between $100 and $250 a week on their shopping bill, an increase of between $40 and $100 from this time last year.

The ACCC noted that the country’s largest players, Coles and Woolworths, were already placing a competitive strain on supermarkets – especially on larger independent supermarkets located close to the two chains.

The removal of Frankin’s from the market place would result in a substantial lessening of competition, the ACCC noted. Prior to the deal, Franklin’s was Metcash’s only real competitor for the wholesale supply of packaged groceries to independent retailers in NSW and ACT.

Independent retailers voiced opposition to the acquisition; they argued that the deal meant that Metcash suddenly became a competitor in the retail market as well.

Metcash is currently on-selling the 80 stores that were owned by Franklins to independent retailers. However the company is holding on to the wholesale part of the business, so these independent retailers will then buy their groceries from Metcash.

The ACCC chairman, Rod Sims said on the ACCC website: ‘We remain concerned that the proposed acquisition would remove any future ability for those independent retailers to choose from whom they get their grocery supplies…The acquisition of Franklins would remove the only option for independent retailers who are unhappy with what Metcash offers them.”

The ACCC had no power to prevent the deal going ahead, as the deal was passed by the Federal Court’s Justice Peter Jacobson.

The ACCC’s lack of power in this event is a troubling development for its chairman Rod Sims. “The Court’s interpretation of some fundamental principles of merger analysis could have serious implications for the ACCC’s ability to block anti-competitive mergers and so protect consumers in the future,’ he argued.

Citi has just dropped its EPS estimates for Metcash by 8.6% in FY12 and 4.8% in FY13. It also dropped its target price from $5.05 to $4.75. Citi notes that Metcash’s sales growth is slower than Woolworths and Coles, and that across the board all retailers have been hit with lower growth expectations.

However Citi retains its buy on the retailer and notes its dividend yield of over 6% – as well as its newly built moat – as being attractive for income-seeking investors.

A sell on Ramsay Health Care (RHC)?


Chart: Share price over the year to 18/11/2011 versus ASX200 (XJO)

Australia’s largest hospital provider Ramsay Health Care is trading at a significant premium to its competitors by virtue of its economic moat and its offshore expansion. 

Ramsay just secured a new $2 billion debt facility for further acquisitions. At its annual general meeting this month, management noted that business conditions so far this year had been bubbling along nicely and in line with expectations. The company is on track to lift its full year earnings by up to 12 per cent – as Ramsay’s 66 Australian hospitals and day surgeries surge ahead.

As a defensive stock, and in the face of an ageing population, shareholders who’ve pinpointed these credentials in Ramsay have been aptly rewarded. The stock is up 21% this year and 417% since 2003. Current dividend yield is 2.6%, fully franked, and the stock is held by chairman Paul Ramsay Holdings (36%), JP Morgan (9.8%) and HSBC (8.8%).

So why does Citi rate Ramsay a sell? It’s the lofty share price that’s worrying the broker. It has a target price of $17.36, which is somewhat lower than the current share price of $18.87. The broker is also concerned about the company’s exposure to the UK and France, with the UK Private Medical Insurance (PMI) yet to recover. Ramsay is at the mercy of Government healthcare policy changes in the UK, as well as Australia. The stock is also trading at a significant premium to its peers, by some 20%, which can suggest the stock is priced for perfection.

However Citi’s sell is the exception rather than the rule as far as Ramsay is concerned. Merrill Lynch has upped its price target to $19.55 from $17.70 following the recent AGM. They reckon now is an ideal time to own the stock. Deutsche Bank is even more optimistic with a price target of $21.

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.