Why Wm. Morrison Supermarkets plc’s Investment Plans Are Doomed To Fail

Today I am looking at why I believe Wm. Morrison Supermarkets’ (LSE: MRW) (NASDAQOTH: MRWSY.US) is in line for further earnings woe.

Competition to stymie investment strategy

Like its UK-listed grocery rivals, Morrisons is devoting vast sums to boost its exposure to the convenience and online sectors. The company admits that “we do not yet have a meaningful presence in online and convenience, the two fastest growing channels in the grocery market,” but is investing heavily in these areas to massage revenues growth.

The company launched its online presence — created in alliance with delivery specialists Ocado as part of a £216m, 25-year deal — in January, and is looking to offer deliveries to half of the country’s households by the end of the year.

As well, Morrisons is also looking to add to its 102-strong portfolio of M Local convenience outlets, having built 90 of these stores in 2013 the morrisonslast year alone. The supermarket plans to dedicate 330,000 square feet of new floorspace to its smaller outlets this year, and a further 300,000 square feet next year. Over the long-term the firm is seeking to “open around 250,000 square feet of convenience space annually.”

Morrisons’ accelerated investment in these key areas pushed capital expenditure 7% last year to almost £1.1bn. But whether these measures will be enough to turn around its ailing fortunes remains to be seen, particularly as rising debt levels is forcing the firm to slash capex by more than half, to £550m, this year and to £400m next year.

The business saw like-for-like sales plummet 2.8% during the 12 months concluding January 2014, accelerating from the 2.1% fall of the previous year, as the effect of budget retailers continues to erode group revenues.

And with supermarket heavyweights Tesco and J Sainsbury also ratcheting up their investment in the critical online and convenience store marketplaces — arenas in which they boast far greater experience than their beleaguered rival — Morrisons’ rising investment in these sub-sectors by no means guarantees of a brighter sales outlook.

A risky pick given enduring sales problems

Morrisons has seen earnings gradually erode over the past five years, culminating in last year’s 2% decline. And City analysts expect the picture to get a lot worse before it gets better — current forecasts point to a catastrophic 44% dive in 2015 before a 16% rebound in 2016.

These projections leave the supermarket changing hands on P/E multiples of 14.4 and 12.4 for these years. Such figures far exceed the value benchmark of 10 times prospective earnings or below, territory which I think Morrisons should be camped within considering its long-running failure to arrest declining sales. I believe that the chain needs to show some signs of recovery before emerging as an attractive stock market selection.

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