Should I Invest In Wm. Morrison Supermarkets Plc?

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By

Kevin Godbold

Published in Company Comment on 22 February 2013

Can Wm. Morrison Supermarkets plc's (LON: MRW) total return beat the wider market?

To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value

If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

So this series aims to identify appealing FTSE 100 investment opportunities and today I'm looking at Wm. Morrison Supermarkets (LSE: MRW), which operates Britain's fourth largest chain of food supermarkets.

With the shares at 262p, Morrison's market cap. is £6,103 million.

This table summarises the firm's recent financial record:

Year to January20082009201020112012
Revenue (£m)12,96914,52815,41016,47917,663
Net cash from operations (£m)579790735898928
Adjusted earnings per share19.7p17.35p20.5p23p25.6p
Dividend per share4.8p5.8p8.2p9.6p10.7p

Morrison's share price has slipped back from the highs it achieved towards the end of 2012. Weak winter trading has sharpened fears about the company's late arrival to the increasingly important online and local shopping arenas. The directors have been talking about difficult markets as cash-strapped consumers increasingly turn to discount-driven and promotion-led food shopping. The firm is putting disappointing sales figures down to inefficiency at getting its sales message across, particularly in terms of promotional innovation and communication of points of difference.

Morrison is the UK’s fourth largest food retailer with over 400 stores and its business is mainly food and grocery. One point of potential difference is that most of the fresh food sold is sourced and processed though the company's own manufacturing facilities, giving it close control over provenance and quality, which could help the firm ride out the current galloping horsemeat scandal!

2012 was tough and the directors are expecting 2013 to be similar. That makes me a little nervous about the total-return prospects for Morrison investors.

Morrison's total-return potential

Let's examine five indicators to help judge the quality of the company's total-return potential:

1. Dividend cover: adjusted earnings covered last year's dividend almost 2.5 times.  4/5

2. Borrowings: net gearing is around 42% with net debt about 2.3 times earnings.  3/5

3. Growth: all of revenue, earnings and cash flow have been growing.  5/5

4. Price to earnings: a forward 10 or so looks up with growth and yield forecasts.  2/5

5. Outlook: recent trading slightly down and a cautiously optimistic outlook.  3/5

Overall, I score Morrison 17 out of 25, which makes me inclined to be cautious about the firm's potential to out-pace the wider market's total return, going forward.

Foolish Summary

Although growth has been good, it looks less certain going forward. There's good dividend cover from earnings, but net debt has been creeping up recently. Recent trading has been weak and the outlook is insufficiently robust to reassure. The valuation looks full compared to growth and yield forecasts. Overall, I'm insufficiently enthused about Morrison to invest right now despite the current forecast dividend yield of around 5%. 

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> Kevin does not own shares in Wm. Morrison Supermarkets.

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Comments

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TMFMarkRogers88 23 Feb 2013 , 3:13pm

Firstly this is a good article summarising the important points in considering an investment in Morrisons.

This is another one of the excellent British businesses that have well and truly delivered value for shareholders over the years. In almost every aspect, they've been sensible and considered in their policies of expansion and investment. They've picked their fights extraordinarily well so far - and they've delivered a long-term record far superior to Sainsbury's. They've not only managed to avoid being crushed by Tesco, they've carved out their own niche for modest, sustainable growth. The Safeway deal now looks to have been very good business for shareholders. Earnings have fallen in only 3 of the last 21 years, in the most part due to integrating the Safeway stores a few years ago. Dividends meanwhile have risen in all but one year since 1992 (where it was flat, again due to Safeway integration), usually by 15-25% a year.

However, I would suggest it somewhat harsh to rank Morrisons at only 2/5 for price to earnings, yield, and other valuation metrics. On a present earnings multiple of less than 10, Morrisons is priced for an indefinite period of zero growth, while yielding 4% historically.

In a period of particularly low interest rates, where high quality companies almost invariably sell for 17-25 times present earnings (4-6% earnings yield), a 10.2% earnings yield is rare to see. That's especially the case where the company is in the process of retiring £1Billion of shareholder equity through buybacks.

In my view, the valuation is the attractive part - the speculative element comes in determining whether Morrisons can continue to deliver as an operating business. The track record would say yes, but management asserts that the "future of retailing is online", and a drastic change to their business model might make it very difficult to predict what the company will look like in five years.

While the valuation perhaps could be as high as "5/5" under certain conservative assumptions, the Outlook rating might well be "Unknowable", incorporating a new degree of speculative risk in the commitment.

With that in mind, not unlike Apple for example, it comes down to the investor's judgment as to the company's ongoing ability to keep earning its current (12-15%) returns on shareholder equity. If an investor is confident of that, and the management's long-term vision, then arguably the current price is very attractive for investment. But the investor must be aware of the additional risk taken by that speculative factor - even with the significant margin of safety built into the price.

This analysis admittedly is made ignoring that Tesco is trading on a very similar "no growth premium" valuation, with perhaps the best retailing record in UK history. But it's a matter for the investor to decide whether the prospects of either enterprise are more attractive, knowing that both face very different scales, opportunities and risks. Good luck to all involved.

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