Life has been difficult for the UK’s four largest supermarkets over the past few years but now the light at the end of the tunnel appears to be shining through.
Morrisons (LSE: MRW) has executed one of the best turnarounds of the group thanks to management’s decision to take the company back to its roots. The firm was built around the idea of offering shoppers high quality produce at low prices, exactly what the hard-pressed UK consumer needs today.
The company’s results for the year ended 29 January 2017 show just how the return to basics has helped it improve its prospects. According to the figures published this morning, for the year Morrisons reported profit before tax up 49.8% year-on-year to £325m and like-for-like sales ex-fuel and VAT up 1.7%, in the first year of positive sales growth since 2011/12. Sales grew above-trend during the fourth quarter with the company reporting like-for-like growth of 2.5%. Turnover for the year was up 1.2% to £16.3bn despite store closures, which shows the strength of the Morrisons brand and is testament to management’s online expansion strategy.
Ready for further growth
Morrisons is firing on all cylinders, and the company is now well-placed to grow steadily over the next few years. What’s more, actions to cut costs, pay down debt and reorganise the company’s store portfolio mean that the firm now looks to be one of the safest investments around.
Indeed, its key strength has always been the balance sheet, which remains the case today. The company has £7.2bn of property and £1.3bn of net debt. Management is looking to reduce net debt to £1bn by the end of 2017/18.
With a reported free cash flow of over £600m for the past two financial years, there’s no reason why the company can’t achieve this target and maintain shareholder payouts. When debt is reduced and profits stabilised, Morrisons will be a cash machine, and I expect management to increase the company’s per share dividend payout dramatically.
At present, the shares support a dividend yield of 2.2%. Over the next decade, I expect it will become one of the market’s best income stocks as it rewards shareholders with hefty cash payouts.
Another long-term play
I believe there are many similarities between Morrisons and Aggreko (LSE: AGK). Like the former was before its turnaround, Aggreko is currently struggling to deal with short term headwinds to its business. However, the company has a history of producing impressive returns for shareholders thanks to its ability to generate a high return on capital invested.
Shareholders have to look past the company’s current pain to see the potential here. In its heyday (2012), Aggreko’s return on equity was an impressive 28.7%, but today this metric has fallen to 10.1%. If the company can reverse its fortunes (which I believe is possible once the softness in the oil and gas market disappears), then it has the potential to generate massive returns as shareholder equity is around 30% higher today than it was back in 2012.
A return on equity of 28.7% on the higher base implies a pre-profit of nearly £400m and earnings per share of approximately 150p (pre-tax). The shares currently trade at a forward P/E of 14 and support a dividend yield of 3.1%.
