The Hidden Nasty In Wm. Morrison Supermarkets plc’s Latest Results

Wm. Morrison Supermarkets (LSE: MRW) (NASDAQOTH: MRWSY.US) reported a 5.6% fall in like-for-like sales over the Christmas period on Thursday, and the supermarket’s share price fell more than 8% — but as investors, could we have seen these problems coming?

Having taken a closer look at the firm’s sales figures for the last few years, I reckon that there were some clear warning signs.

It’s in the margin

The supermarket business model relies on high sales volumes and low profit margins. At the same time, supermarkets’ fixed costs — such as property and staff costs — are quite high, so a small reduction in sales or profit margins can have a big impact on overall profits. (This effect is known as operational gearing.)

A key indicator of a supermarket’s pricing power is its gross profit margin — its turnover minus the cost of goods sold.

Gross Margin Morrisons Tesco Sainsbury
2011 7.0% 8.5% 5.5%
2012 6.9% 8.4% 5.4%
2013 6.7% 6.3% 5.5%
H1 2013/14 6.3% 7.3% 5.6%

Although Sainsbury’s gross margin is lower than those of Tesco and Morrisons, it is very stable, and Sainsbury’s debt levels are lower than those of Tesco and Morrisons.

In contrast, Morrisons’ gross margin has declined steadily over the last three years, and the firm’s latest half-yearly results showed a big lurch lower, while debt levels continue to rise.

Falling sales warning

The 5.6% fall in Morrisons’ Christmas sales took markets by surprise this week, but the warning signs were there for all to see, in the firm’s previous trading updates.

Morrisons’ turnover for the first half of the current financial year was £8,938m, virtually unchanged from £8,939m for the same period last year. When you take inflation into account, this suggests that sales volumes were around 2% lower than for the same period last year, despite the fact that Morrisons opened 33 M Local convenience stores and six new supermarkets during that six month period.

Morrisons’ falling sales were confirmed when the supermarket reported a 2.4% drop in like for like sales in its third-quarter update in November — there were plenty of clues that Christmas could be difficult.

Do shareholders need to worry?

Morrisons will launch its online service later this month, and this may help arrest its declining sales. However, UK supermarkets are remarkably cagey about the profitability of their online operations, and Morrisons’ deal with Ocado certainly didn’t come cheap.

I don’t expect online to be a miracle cure for Morrisons’ woes, and expect the supermarket’s turnaround to take several years.

Is Morrison's dividend safe?

Morrison's shares currently offer a prospective yield of 5.4%, which is the highest available from any UK supermarket. The question for income-seekers is whether this yield is safe: could Morrisons be forced to cut its payout?

I think a cut is unlikely, but ultimately, it's your decision. One way of testing the quality of Morrison's dividend is to apply the 'five golden rules' test that's described in the Motley Fool's latest special report, "How To Create Dividends For Life".

For full details, click here now for instant access to your free copy of this report.

> Both Roland and The Motley Fool own shares in Tesco. The Motley Fool has recommended shares in Morrisons.