Hargreaves Lansdown

Morrison (Wm) Supermarkets (MRW) Ordinary 10p

Sell: 190.90pBuy: 191.10p03.10p (1.60%)
FTSE 1000.31%
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HL comment (12 March 2015)

Full year results from Morrisons are closely in line with the much reduced guidance they had already provided to the market. Their new CEO, David Potts, starts in the business on March 16th and will be providing an update on strategy later in the year. The dividend is raised 5%, as previously promised by the Board, making 13.65p for the year, but the current year’s dividend will be cut to a minimum of 5.0p per share. Like-for-like (LFL) sales are still negative, but the trend is improving, helped by a rising contribution from online grocery sales. Morrison is generating free cash flow and paying down debt, despite the difficult trading environment.

The new CEO is almost, but not quite in situ yet; in his absence the market was unable to find any new catalysts in the statement, leading to the shares to open one to two percent weaker in early trading.

Our View:
Morrison is work in progress. The group are doing the right things in terms of focusing on cash flow, reining back on M:local until it works better, and reinvesting again and again into regaining credibility with their pricing proposition. Online growth is at least offsetting the in-store sales decline somewhat, with the group indicating a 1% benefit to LFL sales.
Cutting the dividend back to as little as 5p saves up to £200m per annum of cash flow. Last year, pre-dividend the group generated almost £800m of free cash flow, so the scope for paying down the debt is clear.

David Potts will have his own stamp to put onto Morrison, but given that he has worked with Chairman Andrew Higginson before, we would be surprised if it were radically different from what Morrison are already aiming for.

Analysts will need to lower their dividend forecasts, for few had pencilled in as large a reduction as now seems on the cards. 5p puts the stock onto a yield of circa 2.5%; it could be a while before the Income Funds come poring over Morrison.

Debt should fall steadily if Morrison can succeed with their cost cutting. But growth could be elusive. LFL sales will be held back by price deflation as Morrison and its rivals cut and cut again. The Discounters have famously low margins and lean operating models. Traditional UK supermarkets have a job on to try and rebuild their margins to historic levels whilst being competitive versus Aldi and Lidl.

It doesn't help that online grocery shopping has dismantled all the old catchment areas that made individual stores so profitable. Effectively, almost every supermarket is competing against everyone else these days, whereas once a store might only have been in real competition with one rival store down the road.

Morrison has a long way to go, but a plan that could get it there. No doubt Mr Potts will provide a bit more detail on the "how" and perhaps a little more clarity on what the outcome might look like. It feels as though Morrison is now hunkering down to get on with the hard work, shorn of the distractions of whether the right board was in charge of the project and free of the burden of an excessive dividend bill.

The shares trade on mid to low teens multiples of future consensus earnings forecasts, with minimal sales growth in the next couple of years. Much will depend on profit margins. At the moment, the market is suggesting margins stay at around 3%.
Morrison faces many, many challenges; it overlaps more with the Discounters than the other Big 4 players we believe, because its stores are more focused on the core range items that the Germans carry than the big hypermarkets are. But it does have solid cash flow and cash is always King.

We can't see an earnings recovery of any scale just yet, but the business will pay down debt quite quickly, becoming a lowly leveraged, asset-rich business, since over 80% of stores are freehold. That free cash flow could be used to retire equity once the business has stabilised, raising the prospect of Earnings per Share growth being leveraged up by buy-backs. It's all a long, long way off, but perhaps there is a glimmer of light at the end of the tunnel at last?

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  • Free cash flow pre-dividend of £785m.
  • Total turnover down 4.9% to £16.8bn (2013/14: £17.7bn).
  • Like-for-like (LFL) sales (ex-fuel/ex-VAT) down 5.9% (2013/14: down 2.8%).
  • Underlying profit before tax down 52% to £345m (2013/14: £719m).
  • Underlying earnings per share down 53% to 10.9p (2013/14: 23.1p).
  • Net debt reduced by £477m to £2,340m (2013/14: £2,817m)

The Details:
Morrison say they have hit all the key guidance metrics they set out in 2014, despite the lower level of sales. Online sales have risen well, fully meeting the company's ambitious expectations, which has limited the LFL decline, which slowed from a low point of -7.6% in Q2 of last year to -2.6% in the final quarter, excluding the impact of fast-falling fuel sales.

Whilst the new CEO is likely to impose his own imprint upon strategy as the year develops, a lot of what is to be done is already known. Morrison will continue to drive down costs, working toward a billion pounds a year of cost savings, which will be largely reinvested into the customer proposition in the shape of lower prices. At the moment, Morrison is investing in pricing first, cutting costs on a catch-up basis, hence the sharp fall in profits. Over time, it hopes to bring the two processes into balance.

The reported underlying profit is after two large items that we would normally consider exceptional. £68m of costs for Kiddicare trading losses, restructuring and the Match & More loyalty card set up costs have been deducted in getting to underlying profit, along with £71M of business development costs incurred in the launch of Online and the development of the M:local convenience stores.

Reported numbers were in loss, largely due to an impairment of £1.3bn against properties, where value has fallen alongside their weaker trading performance.

Cash flow was boosted by the scaling back of capital investment, which more than halved to £520m and which will fall further in the current year to circa £400m before any investment into further online capacity expansion. That helped net debt to fall and the group targets a further fall to circa £2.0bn in the current year, due to the lower capex and the reduced dividend.

The M:local stores are not trading to budget; sales were expected to be stronger in stores' second year, but the expected build has not happened in many cases. Morrison is to close 23 of these stores and slow the openings programme whilst it tweaks the format to deliver better trading results.

The group point out that much of their restructuring and cost savings plans involve bringing systems and processes, especially IT, up to levels that competitors take for granted.

Sales are still weak at Morrisons and the need to invest in pricing and the broader customer proposition will keep profit margins under pressure a while longer. The group is determined to maintain an investment grade credit rating and its medium term capital allocation priority will be the reduction of debt, not dividend growth from the reduced base.

With little by way of new space in the next few years, sales growth will be driven by LFL sales progress and online sales growth. Profitability will be determined by this and the progress in Morrison's £1bn three year self-help programme of cost reductions.

Andrew Higginson, Chairman, said:
"David Potts joins as Chief Executive next week. Under his leadership, we will focus on building trading momentum and being more like the Morrisons our customers expect. We will invest more into the proposition and put customers at the heart of everything we do. We will listen and respond to our customers, and work hard every day to improve the shopping trip. Success measures will be simple - more customers buying more from us. More customers means more volume growth which, ultimately, will lead to better like-for-like, profitability and shareholder returns."

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