Morrisons (LSE: MRW) is a well-known supermarket chain. But people seem to be keener on buying its products than its shares. Last year, like-for-like sales (excluding fuel and VAT) grew 8.6%. But over the past 12 months, the Morrisons share price has slipped around 5%.
Here I consider whether the Morrisons share price is undervalued, and what I’d do next.
Mixed business performance
The headline sales boost is positive. However, sales are only one part of a retailer’s business performance. It is also important to consider profitability.
Last year, for example, total revenue at Morrisons increased 0.4%. With people driving less than normal, petrol sales fell, which reduced the positive impact of higher grocery sales.
But despite a modest improvement in revenue, earnings per share before exceptional items fell 54.9%. Larger revenue didn’t translate to bigger profits.
Profitability challenges to the Morrisons share price
Partly the earnings fall reflected higher costs due to the pandemic.
Some may not recur, but I expect some additional costs related to the pandemic to hang around for a while. My local Morrisons has temporary protective screens at tills, for example. That costs money.
But there are other profit concerns. For example, the company’s storefront on Amazon is now available in around 50 towns and cities. It accounts for more than 10% of sales in most such stores. But Internet sales are often less profitable than in-store transactions, due to fulfilment costs.
That isn’t specific to Morrisons. Tesco has been experiencing the same challenge. But it underlines the risk that growing revenue won’t necessarily translate to bigger profits.
Dividend yield
Morrisons currently yields 6.2%, if special dividends are included. On the same basis, Sainsbury’s pays out 4.2%. Excluding a one-off special dividend after selling its Asian business, Tesco yields 4.0%.
The three chains look broadly comparable to me. Morrisons’ higher yield suggests that it could be undervalued relative to sector peers on this metric.
Price-to-earnings ratio of the Morrisons share price
A common valuation metric for shares is the price-to-earnings (P/E) ratio. Currently it sits at 30, which looks high to me. Morrisons is a constituent of the FTSE 100 index. The whole index currently has a P/E ratio around 20, markedly cheaper than that of the current Morrisons share price.
However, if last year’s earnings hit does indeed prove to be a one-off, the prospective P/E ratio could fall to around 15. On that basis, Morrisons looks undervalued relative to the broad index. But there is a risk that a complete earnings recovery won’t happen.
My Morrisons action plan
I like several things about Morrisons, including its strong brand and online retail expansion.
Risks remain, though — and not just those related to the pandemic. For example, revenue and profit could be hurt by the rise of discounters. That’s one reason I think shares such as B&M performed so well over the past year.
I think Morrisons shares could turn out to be somewhat undervalued, if business performance improves this year. However, for now, it is unclear whether that will happen. So for now I consider the shares to be fairly valued. They may look a bit cheap, but I think that is because the market is discounting them for the uncertainty of an earnings recovery.
I will continue to watch the Morrisons share price from the sidelines for now, but won’t be adding them to my shopping list.
