Successful investors use a disciplined approach to picking stocks, and checklists can be a great way to make sure you’ve covered all the bases.
In this series I’m subjecting companies to scrutiny under five headings: prospects, performance, management, safety and valuation. How does Morrisons (LSE: MRW) measure up?
The UK grocery sector is mature and constrained by tight consumer spending, so the major supermarkets compete for market share mainly on price.
Morrisons is fourth largest with a 12% share. Its distinctive positioning is vertical integration into food production and an emphasis on fresh foods. It has been behind the curve in developing online sales and convenience stores, the two segments where there is significant growth.
However, it is now catching up, with a paradigm-shifting deal with Ocado, purchase of former Blockbuster, Jessops and HMV stores for its convenience chain, and a £300m budget to upgrade IT systems. The latter will enable Morrisons to participate more effectively in price promotions, and generate cost savings.
Morrisons has seen steadily increasing turnover, both before and after its acquisition of Safeway in 2004. Profit and EPS has been more variable, but it has consistently increased dividends whilst rarely dropping below two-times cover.
Dalton Philips has been CEO since March 2010 when he succeeded Marc Bolland, the marketing guru now struggling at Marks & Spencers. A former chief operating officer of Walmart Germany, Mr Philips recently blamed Morrisons’ slow development on his predecessors.
As Warren Buffett says, “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
Generally, supermarkets have low financial risk. Morrisons’ 40% net gearing is in line with the sector and 12-times interest cover is safe. The net pension deficit is trivial and gross liability less than half Morrisons’ market cap.
Most of the firm’s profits are turned into cash, and historically free cash flows have funded significant own-share purchases, giving the company headroom to increase capex.
Morrisons’ prospective price-to-earnings ratio of 11.4 is marginally lower that of Tesco and Sainsbury’s. It is also lower than Morrison’s historic trading range, while the 4.5% yield is higher than in the past. In part that reflects the shares’ underperformance against the FTSE 100 and the sector over the past 12 months.
Morrisons’ relative cheapness could present a buying opportunity for investors who have faith in Mr Philip’s turnaround/catch-up plan. However, some may question why it’s taken three years to devise, and wonder if the quote above from Warren Buffett is pertinent.
Mr Buffett has, of course, invested into the UK supermarket sector, one of his rare investments outside the US. It’s instructive to look at why he picked Tesco. “The One UK Share Warren Buffett Loves” tells you all about it. You can download it by clicking here — it’s free.
> Both Tony and The Motley Fool own shares in Tesco. The Motley Fool has recommended shares in Morrisons.