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Morrison (Wm) Supermarkets (MRW) Ordinary 10p

Sell: 168.20pBuy: 168.50p00.40p (0.24%)
FTSE 1000.90%
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HL comment (7 May 2015)

Morrison's shares are "ex" a final dividend of 9.62p today, but have opened an additional 1-2% lower after their Q1 trading update, which showed the business treading water, with no improvements really visible, but no deterioration either. Details are scant and there is no significant strategic update from newly arrived CEO, David Potts.

Highlights:
  • Total Sales (ex-fuel) were down 1.1% for the 13 weeks to May 3.
  • Like-for-like (LFL) sales were down 2.9% ex-fuel, or 6.6% including. This compares to -2.6% in the final quarter of last year, and -7.1% in the comparator quarter.
  • Online sales boosted the LFL number by 1.0%.
  • Store closures were greater than openings; net space fell by 50,000 ft² in the quarter.
  • Head Office restructuring costs of £30-£40m to be incurred this year.
  • Net debt fell by around £150m in the quarter, to £2.2bn. 

Items per basket have pretty much stabilised. Having been falling at an annual pace of 5.9% in Q1 of last year, the decline in the latest quarter was just 0.1%. 
But the number of transactions is still declining at a meaningful pace. In Q1 last year, the rate of decline was 3.6% p.a. and this slipped from -1.9% in Q4 to -3.2% in the latest period.

Morrison is weeding out the weak performers in its range, with the number of lines stocked (SKUs) falling from 23,600 to 21,650. Promotional activity is also reducing, in favour of lower everyday prices. Year on year, the number of items on promotion has fallen in each of the last five quarters, with the last quarter seeing a decline of 4.3%, equivalent to a 210bp fall in the percentage of sales made from promotional lines.

Outlook:
Morrison are undertaking a full assessment of the business under new CEO David Potts, and the results of this will be released later in the year. In the meantime, the company has said that they expect profits to be weighted toward the second half of the year and that as described at the full year, the focus is to invest more for customers in order to build trading momentum, rather than achieve quick, but potentially short-lived financial benefits.

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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 2.8%; 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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