Is Metro (TSE:MRU) Canada’s Best Defensive Stock?

 

If Canadians learned one thing in 2020, it’s that they need to add strong defensive stocks to their portfolio to avoid unnecessary volatility.

Most of these defensive options are also excellent Canadian dividend stocks, which is an added bonus to their defensive nature.

One stock I’m going to look at today is a popular Canadian grocer, Metro (TSE:MRU). There’s a lot of debate on what Canada’s best grocer is in terms of both dividend, growth, and future outlook.

I’m going to tackle it all in a single article. Lets get started with what the company does.

 

Lets take a look at Metro (TSE:MRU) stock

Metro is a Canadian retail company that specializes in both food and pharmaceutical products.

The company has over 950 food stores, operating under the brands Metro, Metro Plus, Super C, and Food Basics. It’s pharmaceutical sector includes over 650 drug stores under the Jean Coutu, Metro Pharmacy, and Food Basics Pharmacy brands.

The company’s move into pharmaceuticals didn’t come until 2018 when it made a large acquisition of Jean Coutu.

Metro operates both as a retailer operating individual stores and as a franchisor, licensing its trademarks and supplying merchandise to franchisees.

The company has a high exposure to Quebec, with over 70% of its stores being located in the province.

 

How is Metro’s dividend?

Out of all the consumer staple stocks here in Canada, you’d have a tough time arguing that Metro doesn’t boast the best dividend out of the bunch.

Now, the company doesn’t yield much at 1.44%, but it has been growing it’s dividend at a rapid pace recently, and as you’ll see when we move through this article, it’s still got plenty of room to run.

 

 

In terms of dividend growth streak, Metro has grown it’s dividend for 25 straight years, the longest streak in the consumer staple sector.

In fact, the company has the seventh longest dividend growth streak in the country and has been one of the poster-boys on the TSX in terms of strong dividend growth.

Metro has grown its dividend at a 14.90% clip annually over the last 5 years, and although it’s recent increase fell well below this mark, I still think the company is going to be able to grow the dividend at a double digit pace moving forward.

The secret lies in Metro’s low payout ratios across the board.

 

Market Cap: $15.71 billion
Forward P/E: 18.10
Yield: 1.44%
Dividend Growth Streak: 25 years
Payout Ratio (Earnings): 28.21%
Payout Ratio (Free Cash Flows): Premium Members Only
Payout Ratio (Operating Cash Flows): Premium Members Only
1 Yr Div Growth Rate: 11.11%
5 Yr Div Growth Rate: Premium Members Only
Stocktrades Growth Score: Premium Members Only
Stocktrades Dividend Safety Score: Premium Members Only

 

Metro currently has a payout ratio of only 21.43% in terms of earnings. As we can see, this is pretty typical for the company over the last half decade, and even more impressive is the fact the company was able to reduce it’s payout ratio over the course of this pandemic.

I mean in a way it makes sense, its operations were not impacted whatsoever. In fact, panic buying actually boosted earnings.

Its dividend starts to look even nicer when it comes to free cash flows, as at the time of writing it’s only paying out 26.48%.

Moving forward, I’d expect Metro to keep up with its current pace of dividend growth, and the company has given absolutely no indications or hints that a dividend cut or stalled growth is even remotely in the works.

But, what will keep this dividend growing moving forward? Ultimately it will require the company to grow both its earnings and sales. Lets look at how it’s going to do that.

 

Overall outlook for Metro stock moving forward

 

 

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If we look at overall performance over the last half decade in terms of major grocers, Metro has a huge advantage. It’s returned nearly 70% on a dividend adjusted basis. The closest grocer Empire Company, which owns popular brands like Sobeys, lags by over 3000 basis points.

In my eyes, Metro is firmly planted in blue-chip territory when it comes to Canadian stocks. The company has a market cap of around $15.6 billion and a strong foothold in Quebec.

As such, I don’t expect it to provide world-beating top and bottom line growth. And there are some concerns here with Metro.

Over the last 5 years, the company has grown earnings by 3.9% and sales by 3%. The issue lies within the shrinking of these numbers when we look more short-term.

If we look to the 3 year period, Metro’s earnings have decreased by 1.7% annually and sales have been relatively flat.

There’s also the fact that Metro has beat on earnings expectations only 3 of the last 12 quarters.

Moving forward, I’d expect Metro to post much of the same, and as a result this isn’t a stock I’d be looking at if you’d like strong capital appreciation.

In fact, I’d go as far to say the stock is overvalued at current price points.

 

How does Metro’s valuation look right now?

The company is currently trading at a double digit premium to its historical average in terms of price to book, price to sales, and price to earnings. To be honest, this doesn’t surprise me right now.

2020 has been anything but normal, and when the markets get rocky people tend to flock to defensive style stocks. That’s exactly why Metro is up 16.2% year to date, while the TSX has lost 6.1%. This is a significant outperformance.

 

 

If we look at the chart, we can see that despite the TSX posting a record breaking collapse during the market crash of 2020, Metro’s price barely moved, and has steadily trended upwards from there. The same cannot be said for the share prices of many Canadian oil producers, such as Suncor Energy (TSE:SU), who have been greatly damaged by a slump in the price of oil.

Metro is trading at 18.5 times forward earnings, which is 10% higher than it typically trades at. Considering this company is expected to only grow its bottom line by low single digits over the next couple of years, I’m not sure I’m willing to pay nearly 20 times earnings for this.

Sure, the company pays a great dividend, but I think there may be a chance a Canadian investor underperforms purchasing Metro at these price points. In fact, analysts see next to no upside in todays pricing, placing a target price point of $62.50 on the stock, which is essentially what it’s trading at at the time of writing. They’ve also placed a firm “hold” rating on the stock moving forward.

So, if we factor in that we may see flat growth from the company in terms of stock price moving forward, it’s 1.4% dividend yield just doesn’t cut it in terms of overall returns. In fact, we’re underperforming inflation here, and our capital is losing buying power. This is a key concept to understand if you’re new to buying stocks in Canada.

I get the defensive aspect of it, but there is fixed income that provides these types of returns and garners significantly less risk than individual equities.

Metro is a stock I’m putting on my watchlist for when the dust settles with COVID-19, but it’s not a stock I’m touching right now.