After enduring years of criticism for being late to the online and convenience shopping party, Morrisons (LSE: MRW) announced this week that it is selling almost all (140) of its high-street convenience stores and won’t be making any further investment in small-store formats.
This now leaves Morrisons a purely “out of town” play, with an almost exclusive focus upon large-store format shopping. It also further concentrates the group’s exposure to the less affluent North of England, where discount stores are not short in number.
For these reasons, Morrisons’ future viability will now be determined entirely by its ability to compete with the discounters, head on, on price!
After considering this, I can’t help but feel that an even longer and darker shadow has just been cast over the horizon for shareholders at Morrisons, particularly when considering the implications that this will have for margins, dividends and dividend cover over the medium term.
Meanwhile, over at Tesco…
My sentiments are broadly similar toward Tesco (LSE: TSCO), a company whose price leadership ambitions will probably ensure that, at best, its trading profits remain depressed for at least the life of the group’s discount drive.
Consensus estimates for the group confirm as much, with even the most optimistic of forecasts suggesting that Tesco will struggle to reach £1.4 billion in trading profit and 10.6 pence in EPS for the full year.
More importantly, even if the group does achieve the above figures, a likely £1.4bn-£1.9bn in admin and finance costs for the period will mean there remains a genuine possibility the group will be forced to report another loss for the 2015/16 year.
In addition, Tesco’s balance sheet remains stretched following years of remorseless expansion, with debt/equity increasing by 100% to 1.8x and gearing up to 64% during last year alone.
This means that most of any funds raised from asset sales (estimated £6bn) will probably be earmarked for debt repayment and even then, this will only serve to bring the group’s leverage back within an acceptable range.
Tesco also has a cash flow problem, which it plastered over last year by issuing nearly £5 billion in new debt.
With the day-to-day operations and activities of the business consuming more than 3x the level of cash the group can generate from operations, it is now essential that management slims down the group cost structure and drastically reconsiders its plans for capital expenditure.
While it is possible that the re-jigged team in the boardroom may eventually get the bull by the horns, my natural sense of scepticism is overwhelming in relation to some of the above questions. For this reason, I find it difficult to view Tesco and Morrison as anything more than a last chance saloon for either the incredibly patient, or for those with an almost masochistic inclination.
Sainsbury’s, On The Other Hand…
Sainsbury’S (LSE: SBRY) on the other hand, could be worth holding on to. This is because the group has taken a fundamentally different approach to addressing the rise of the discounters, one which has seen it enter into a joint venture to create its own discount chain in the UK (Netto’s).
In doing this, Sainsbury’s has been able to cap the cost of its own discount drive at £150 million and avoid permanently rebasing the price expectations of its own customers, while also putting the rest of the industry to shame on the question of adaptability.
Most importantly, sales growth is not completely dead at Sainsbury’s, and with management’s disciplined approach toward costs, price competition and brand positioning taken into account, it could now avoid the worst of the earnings contraction experienced by its peers.
This and a sturdy balance sheet should provide the group with a good chance of maintaining its regular dividend at a similar level to those of recent years which, in addition to being a welcome development for existing shareholders, may even prompt a degree of outperformance from the shares over the medium term.
