The Surprising Sell Case For Wm. Morrison Supermarkets plc

Today I am looking at why I believe shares in Wm. Morrison Supermarkets (LSE: MRW) (NASDAQOTH: MRWSY.US)  are set to experience mounting pressure as the firm’s recovery strategy struggles to take off.

Sales performance continues to drag

The supermarket’s latest half-yearly report showed that Morrisons’ turnaround strategy is still failing to yield results. Total revenues remained flat at £8.9bn in February-August, the company announced, while pre-tax profit plummeted 21.8% from the corresponding 2012 period, to £344m.

The retailer has failed to arrest the long-running issue of slowing product sales, with total store sales rising just 0.8% in the six months versus growth of 1.3% last year. And most worryingly was an accelerated slump in like-for-like sales — these dropped 1.6% in February-August compared with a 0.9% fall in the same period last year.

Bafflingly, Morrison saw its share price hit its highest for 18 months at 302.5p following the announcement. And although prices have since receded from these levels, in my opinion the supermarket’s stock remains chronically overvalued — for the current year this stands at 11.4, above the bargain benchmark level of 10, which I believe the firm should be firmly encamped below.

By comparison, J Sainsbury — whose sophisticated multi-channel growth strategy and extensive brand development should continue to reap steady revenues and profits expansion — trades on a modestly higher figure of 12.5 for 2013.

Morrisons bulls point to the company’s tie-up in the summer with online grocery specialists Ocado as a future earnings driver, which will see the former belatedly enter the internet shopping space from early next year. But the supermarket’s well-established online rivals have both the expertise and resources to target the new entrant and severely hamper performance from the outset.

And while the company’s overtures into the convenience store space is also a step in the right direction — Morrisons’ switch from opening new ‘megastores’ to smaller outlets will result in 100 of its ‘M‘shops becoming operational by the end of the year — the firm will also face a fierce fight in this area from the likes of J Sainsbury, Tesco and Waitrose who are also significantly expanding their own range of convenience stores.

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Morrisons announced in its half-year update that it was raising its interim dividend by 10% to 3.84p, and from next year onwards plans to maintain a progressive dividend policy with coverage of 2 times underlying earnings. This was almost certainly responsible for the post-results share price spike.

 But with earnings widely expected to fall this year, and substantial growth drivers for the long-term appearing speculative at best, I believe that the supermarket remains a risky pick for those seeking access to either solid earnings growth or meaty dividend income.

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> Royston does not own shares in any of the companies mentioned in this article. The Motley Fool has recommended shares in Morrisons.