After a difficult few years shares of grocer WM Morrison (LSE: MRW) have been a surprise standout over the past year, rising in value over 45%. But, with earnings still a fraction of what they were just five years ago, shares are looking highly valued at a full 22.5 time forward earnings.
Plan paying off
That said, while investors may have got slightly ahead of themselves, signs are emerging that Morrisons’ ambitious turnaround plan is paying off. The company’s Christmas trading statement showed that like-for-like non-fuel sales rose 2.9% year-on-year in the nine weeks to 1 January. These strong same-store sales more than compensated for the closure of non-performing locations, and total non-fuel sales were up a solid 2%.
This suggests that management’s plan to close poorly performing stores, renovate retained locations, and refocus on offering core food items at competitive prices is working. Positive sales momentum is feeding through to the company’s finances as well as free cash flow in H1 increased 16% to £558m. Higher cash generation is being used to pay back creditors and management now expects year-end net debt to reduce to a very manageable £1.2bn. This is a significant improvement on the £2.8bn of net debt the company was saddled with as recently as fiscal year 2014/15.
Morrisons’ turnaround is progressing well, but its share price already has considerable future growth baked into it, so I’ll be staying away from this grocer for the time being.
Major dangers lurking
All UK-listed airline stocks were battered after the Brexit vote in June but shares of Ryanair (LSE: RYA) have gained back lost ground and more, and now trade above their pre-referendum closing price. But has the market got ahead of itself in anticipating clear skies ahead for the Irish budget airline?
Well, its shares aren’t particularly pricey at 13.9 times consensus forward earnings, but there are major dangers lurking for all European carriers. The first is that passenger demand growth is slowing as Eurozone economies stagnate, decreasing the number of both business and pleasure travelers. The second is that while positive demand growth is always good news, airlines are also repeating their age-old mistake of adding capacity faster than demand grows.
For airlines this inevitably means excess capacity. And no airline wants to fly with empty seats, which leads them to slash prices in order to keep load factors high. We’re already seeing this effect in European budget airlines such easyJet, who reported on Tuesday that average constant currency revenue per seat fell 8.2% year-on-year due to price wars even as it boosted capacity by 8.6%. Ryanair is beginning to suffer from the same problem as its average fares fell 10% in H1 and management guided for a further 13-15% decrease in H2.
Luckily it seems that the OPEC supply-cut agreement isn’t sending oil prices skyrocketing, which would obviously be bad news for airlines. However, $50-per-barrel oil won’t compensate for the fact that fares are dropping precipitously, as capacity across the industry grows at a breakneck speed at the same time as demand growth slows. Falling fares coupled with the highly cyclical nature of the industry means I wouldn’t be surprised to see Ryanair shares fall in the year ahead.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.