The London-listed supermarkets saw their share prices start to rebound during October. Today, Tesco (LSE: TSCO) is up 14% from its recent nadir, J Sainsbury (LSE: SBRY) is up 19% and Wm Morrison Supermarkets (LSE: MRW) is up the furthest of all at 20%.
Is this the start of a longer trend or just the first of several small bounces just as we get when dropping a football from an upstairs window? Let’s look for some clues.
A changing landscape
Supermarkets operating in the middle space such as Morrisons face a period of intense industry competition and structural change, according to the firm’s management statement released earlier this month. Morrisons’ boss must feel a bit like a subsistence farmer surveying his little patch of land after a plague of locusts passed through.
The trouble is this time, I don’t think green shoots are coming back. As I gaze into my crystal ball, one possible future I see is the continuing ascendancy of a new lean, mean breed of discounters such as Lidl, Aldi and others, and the existing, bloated incumbents managing an orderly retreat based on downsizing and asset sales. We could even see operators like Morrisons selling supermarket space to new upstarts such as Aldi — that would be interesting.
Things may not work out exactly as my vision suggests, but the tide is definitely against Morrisons and its peers, and that is not a good starting point for an investment. Ideally, we want to be investing in up-and-coming sectors, not in down-and-going ones.
Fighting back
Of course, Morrisons is fighting back, but I can’t help picturing a frog’s hands gripping a heron’s throat as its body disappears down the bird’s gullet! Measures include slashing the prices of 1,200 products; finding £1 billion in cost savings over three years; improving the layout of big stores, and investing in the opening of 200 convenience stores. However, such initiatives net out to a struggle for survival and not a climb back to previous glories, in my view.
The recent third-quarter update shows total sales excluding fuel down by 3.6% and like-for-like sales down 6.3%. Morrisons reckons it will take time for the firm’s initiatives to benefit sales performance, but there is encouraging progress in all components of the turnaround strategy.
Morrisons continues to invest in store cards and discount vouchers, launching Match & More, the firm’s new price match and points card which provides, the directors reckon, a unique price guarantee against Aldi, Lidl, Tesco, Sainsbury’s and Asda. The card is already proving extremely popular with customers, they say, but they didn’t ask me. If they had, I’d have told them that such time-consuming nonsense is enough to drive me elsewhere for my groceries. Why not just sell the stuff as cheaply as possible and leave it at that — life’s too short!
Outlook
Underlying profit before tax will come in between £335million and £365million in the current year say the directors. That’s a sobering thought that underlines just how much things have changed for the firm. Three years ago, Morrisons posted £947 million.
City analysts following Morrisons reckon profits will stage a modest bounce-back during year to January 2016, rising around 12%. To put that in perspective, the current year’s profits look set to come in down about 50%.
At today’s 183p share price, Morrisons trades on a forward P/E rating of about 13 for 2016 and the forward dividend yield is running at around 5.6%. However, adjusted forward earnings only cover the payout about 1.3 times, which is thin.
If we adjust the cover for a more comfortable two times earnings, the yield would be around 3.8%, which strikes me as a better figure to consider for valuation purposes. Therefore, Morrisons valuation looks rich, unless we believe that the firm’s profit bounce-back is sustainable.
What next?
To me, there is just too much downside risk. Morrisons today doesn’t strike me as value proposition or a decent turnaround candidate. We could see a bit more share-price bouncing yet, and if we are thinking of a defensive investment, perhaps we should look elsewhere such as the other firms on the London stock market with strong trading franchises that can really drive wealth creation if we buy the shares at sensible prices.
