ancial hole in FY15 that led to $384 million loss for the year following heavy writedowns on its accounts. Morrice divested the automotive division that Metcash has built through a series of acquisitions to reduce debt levels and worked to consolidate the business and reinvigorate flagging sales and earnings in the core IGA supermarket business. For most of the past three years, Morrice has concentrated on a strategy to ensure that the independent IGA store network can compete in an increasingly competitive grocery market. Protecting the independent network, let alone achieving growth, has been a formidable task, given the expansion of Aldi into South Australia and West Australia, traditionally the two strongest states for Metcash in market share. That challenge is now Adams’ task and while Metcash is fundamentally sound financially and in a better relative position on debt, the wholesaler is facing an uphill battle to secure its customer base let alone retain market share, sales and earnings growth. For the first half of the current financial year, Metcash lifted sales by around $500 million to $7.06 billion compared to 2016, but virtually all of that gain was due to the acquisition of the Home Timber and Hardware business from Woolworths and Lowes in October 2016. Despite new store openings and a significant investment in store upgrades, marketing and price, the core IGA supermarkets business has shed sales and earnings growth over the past three years. In the latest half, Metcash reported that food sales declined 1.4 per cent to $4.36 billion with like-for-like sales across the IGA store network down 1.1 per cent. Morrice noted that food deflation was running at 2.7 per cent and was a factor in the decline, but the result in terms of growth was still below the comparable results for Coles, Woolworths and Aldi and represented a fall in market share. Morrice noted that South Australia and Western Australia, the former independent strongholds, have been weaker than the eastern seaboard states, reflecting the rollout of Aldi stores in those two states. Metcash took some comfort from a stronger second quarter than for the first quarter, showing some resilience against what Morrice described as “significant competitor investment in price and promotions” and the expanded store networks of competitors. A tough job ahead The problem for Adams and Metcash is that business is unlikely to get any easier or less competitive in the future with Aldi continuing to expand its footprint nationally, Costco rolling out stores and another German discounter, Kaufland, set to launch its hypermart format in both Adelaide and Melbourne. Coles and Woolworths are obviously responding to the international competitors to protect their market share which, in turn, translates not just to sales and earnings but also buying power. Metcash is kicking some early goals with its hardware division, which has benefited from the exit from the market of Woolworths Masters Home Improvement chain. Hardware sales increased $482.6m to $1.06bn in the first half ended 31 October. Morrice claimed the result reflected strong underlying sales growth for the business, but the result was obviously bolstered by a full six-month period of Home Timber and Hardware sales compared to one month in 2016. Mitre 10 delivered like-for-like wholesale sales growth of around six per cent in the half while Home Timber and Hardware had comparative wholesale sales growth of three per cent and promises to generate further improvement as it is fully integrated in the Metcash wholesale division. The greater scale of the hardware division and sales gains virtually doubled earnings before interest and tax from $14.6 million in the corresponding first half in 2016 to $27.1 million in the latest period. A crystal ball look at the future of Metcash might well reveal a greater reliance on the hardware division for growth as the food business declines. Quite apart from the direct competitive impact of the new players in the grocery market and the defensive actions of Coles and Woolworths, Metcash is likely to see its store network contract as independent retailers quit the industry. Metcash has secured its business in recent years by taking a stake in a number of the larger independent chains and by persuading the Australian Competition and Consumer Commission that the acquisition of the stronger independent stores by chains was adversely impacting on competition and was detrimental to suppliers and consumers alike. The creeping acquisitions have virtually stopped, but may well return as the growth of Aldi, Costco, Kaufland and potentially an Amazon online food offer encourage a redefinition of competition in local markets as well as the broader grocery market. The threat of Drakes Perhaps more worrying for Adams and Steven Cain, another former British retailer who heads the supermarket and convenience division at Metcash, is the prospect of independent retailers abandoning the grocery wholesaler. Drakes Supermarkets has around 50 stores throughout South Australia and Queensland generating annual sales of more than $1 billion. The chain has recently rebranded its Queensland stores, dropping the IGA identity and trading simply as Drakes Supermarkets. The decision was prompted by concerns that the IGA brand was limiting the chain because the customer perception of what Drake’s larger Supa IGA stores offered in range, services and pricing was blurred by their experience of the smaller IGA stores. There is speculation that Drake supermarkets might consider a breakaway from Metcash and CEO Roger Drake has indicated all options are on the table in terms of sourcing product. Understandably, Drake wants to source product on the best possible supply terms to ensure his stores can be competitive with the chains. There are new and emerging options for chains like Drakes Supermarkets, including digital buying platforms and other wholesalers. However, the most threatening option as far as Metcash would be concerned would be if Drakes and potentially other independents retailers decided to source direct. As mentioned earlier in this article, Metcash has sought to protect its interests by taking equity positions in some its major retail customers and that includes a 26 per cent stake in Dramet, which owns 15 Drake Supermarkets. Metcash may well rely on the contracts supporting those equity positions to prevent a major walkout of retailers who are concerned about the performance of the grocery wholesaler and its capacity to keep them competitive. A one-two punch One possibility that would devastate Metcash would be for Drake Supermarkets and the 76 store Ritchies IGA chain to merge and list on the Australian Stock Exchange. Ritchies stores are located in Victoria, New South Wales and Queensland and are also Supa IGA large footprint supermarkets that compete directly with the chains. Metcash also has an equity shareholding in Ritchies but it’s debatable whether or not that would be sufficient to prevent a breakaway in the case of a decision to seek a public listing. Roger Drake and Fred Harrison, Ritchies IGA CEO, are the most influential men in the independent supermarket sector and a move away from Metcash by them could potentially attract other defectors, such as some Drake’s Foodland South Australia colleagues or even the Victorian-based FoodWorks chain, which is not as tightly tied to Metcash. Notwithstanding the rebranding of Queensland stores by Drake and his comments on considering all options on supply, there is not necessarily an imminent threat to Metcash. However, Adams must recognise that among the tests he faces as CEO, could well be the crucial challenge of retaining the customer base in the grocery sector.