A Spruced-Up Morrisons Looks Like a Bargain
Management is embarking on an overhaul that should repackage the supermarket company and better position it to take on its British rivals.
Investors browsing the aisles for British supermarket stocks might not like what they see these days, but Morrisons could offer good long-term value.
Wm Morrison Supermarkets, known as Morrisons, has been pushed to the back of the shelf, bruised by fierce competition and a strategy that had passed its sell-by date. But management is embarking on an overhaul that should repackage the supermarket company and better position it to take on its British rivals.
The stock (ticker: MRW.UK) recently has taken a beating, losing almost a quarter of its value in the past 12 months. It was knocked down 12% on Thursday alone after reporting a loss for the fiscal year ended on Feb. 2, dragging down other retailers with it. (Morrisons has unsponsored American depositary receipts that trade in New York under the ticker MRWSY .)
It closed on Friday at 208 pence ($3.46), or roughly 11 times estimated earnings for the next fiscal year, and in line with market leader Tesco (TSCO.UK). Most analysts are neutral on Morrisons' stock, rating it Hold with a consensus price target of 225 pence. However, the more bullish suggest it can climb to 270 pence in the next 12 months, which would represent an upside of 30%.
The United Kingdom market has been tough for the Big Four domestic players—Tesco, J. Sainsbury (SBRY.UK), Wal-Mart Stores' (WMT) Asda, and Morrisons—as consumers tightened their belts in recent years amid an economic slowdown. At the same time, discounters made huge inroads.
Morrisons was hit harder than the other major supermarket chains because it didn't offer online sales—a serious error in an age when more people are shopping on the Internet. What's more, its outdated IT systems meant it couldn't provide a loyalty plan or personalized couponing, important considerations for shoppers on strict budgets.
Morrisons' weak position is evident. The company reported an 11% drop in operating profit to 865 million pounds ($1.44 billion) on a 2% drop in revenue to £17.68 billion in fiscal 2014. Restructuring costs of more than £900 million and other charges pushed it to a net loss, equivalent to about 10 pence per share.
But the Bradford, U.K.–based company is addressing its problems and appears to be taking the right steps to make up for lost time. Morrisons announced a deal last summer to offer food online in partnership with Ocado Group (OCDO.UK), an Internet grocer. The venture made its first delivery in January. Last year, Morrisons entered the fast-growing market for convenience stores, catering to customers who don't have time to visit supermarkets.
An IT upgrade is also near completion. The new system will allow Morrisons to more effectively manage its supply chain, and track stock to improve service and in-store availability. A loyalty card should be rolled out this year.
These improvements will bring Morrisons back into line with rivals, but they come at a cost: capital expenditure has topped £1 billion a year for the past couple of years. That period seems to be the top of the cycle. Capex should fall to £550 million this year and £400 million in 2015.
Morrisons reckons the measures it is taking will contribute £1 billion in savings through the next three years, with half of that coming from promotional activities. Coming off such a low base, that may be conservative.
The company also expects to raise £1 billion from property disposals in the next three years. It has a strong property portfolio that it says is worth about £9 billion—almost double its market value of some £4.86 billion.
Good execution should help Morrisons reach its target of £2 billion of free cash flow over the next three years. Free cash flow was negative last year. Making progress toward that goal will be critical to its success. A consensus of analysts' estimates forecast a profit of 18 pence a share for the current year.
Morrisons is confident. Despite posting a loss, it hiked its full-year dividend, keeping a prior promise, and pledged to boost its payout this year by at least 5% to a minimum of 13.65 pence per share. Morrisons stock currently yields more than 6%.
Investors should be tempted by what Morrisons now has on offer.
AMSTERDAM-LISTED Altice (ATC.Netherlands) can offer upside if it can secure a deal to acquire Vivendi's (VIV.France) mobile business, SFR. Discussions are ongoing, and the price tag is reportedly close to 12 billion euros ($16.7 billion). Altice consolidates mobile and cable assets, and has a track record of improving margins by purchasing scale and renegotiating contracts. SFR would represent a good opportunity for Altice, whose shares closed on Friday at €30, giving it a market cap of €6.20 billion. The stock isn't widely followed, but Credit Suisse reckons it could climb to €35.90 a share in 12 months.