I embraced this philosophy recently when I noted that lithium miners are starting to look less speculative and more like solid long-term investments. And I’m doing it again today as I consider McColl’s Retail Group (LSE: MCLS) despite possessing no sector expertise.

So why has McColl’s caught my attention? Because since August the share price has nearly halved to reach an all-time low. At the time of writing, it is trading at 19.7p, far below its 52-week high of 40.8p. Its current market cap is just £55m.

In February I stated that PayPoint was fighting fit for the future despite being over punished by investors for the perceived impact of the pandemic and that the stock would see a 65% appreciation during 2021. Since then, the stock is up more than 20% and has paid out a dividend with a yield of 4.5%. Today I would make the same prediction about McColl’s.

What is good about McColl’s?

On the face of it McColl’s looks solid. It has £1.26 billion of revenue and a gross profit margin of 23.9%. It operates over 1,300 convenience stores and newsagents that 22% of customers visit every day. Many McColl’s stores also have other community facilities. 1,300 McColl’s stores also offer bill payment counters, ATMs and parcel collection/return points (all of these extra services, incidentally, are provided by PayPoint).

A new vogue for working from home will likely increase demand for local convenience shopping, and McColl’s has already been expanding its position for some time. In 2016 the company bought 298 convenience stores from the Co-operative Group in a £117m cash deal. The acquired stores were profitable and, despite the transaction driving up McColl’s’ net debt, it gave the company greater exposure to the trend for ‘mid-sized local’ shopping, with the average co-op store acquired being 45% bigger than the average McColl’s store.

In another adept move, in 2017 McColl’s signed a deal with Morrisons to supply all of its stores; and in 2021 McColl’s extended this wholesale partnership by rebranding 300 of its stores to become ‘Morrisons Daily’ stores under a franchise agreement running to 2027. This franchise agreement has become a cornerstone of the future investment story for McColl’s.

So why has the McColl’s share price tanked?

Things started getting a bit tricky for McColl’s in August 2020. Net margins were already slim, and the impact of the Covid-19 pandemic meant that broker Peel Hunt cut its price target to 50p, down from 70p.

One year later when McColl’s reported interim results for the six months to May 2021 in August 2021, sales growth had slowed to just 1% and revenue was down 5.3%, with a net loss before tax of £2.1m. Those figures might not be thrilling, but it’s a respectable showing given the challenging circumstances of the UK coming slowly out of a long lockdown.

Net debt stands at £111m, mostly a legacy of the Co-operative Group deal and the cost of transforming McColl’s stores into Morrisons Daily format franchises, with 100 conversions due to be complete by the year end, which McColl’s says will have a payback period of 2-3 years.

But this is also where McColl’s has come unstuck. With relatively modest EDIT in good times, its wafer-thin net margin in the wake of post-Covid disruption has left it with little room to invest in store conversions from retained earnings, and no capacity to take on any further debt.  Given the importance of the Morrisons Daily store transformations, in August 2021 McColl’s was forced undertake a share placing to raise £35m to fund the program.

The timing was awful. Just one-month earlier, McColl’s had been forced to put out a statement to reassure investors that the prospective $8.7 billion takeover of Morrisons by a private equity group would not impact the existing wholesale or franchise agreements that McColl’s had already predicated its entire future investment story upon.

But shareholders remained sceptical. They took just 60% of the shares available from the share placing at an aggregate price of just 20p per share. The McColl’s share price tanked.

McColl’s: to buy or not to buy?

My view is that had the Morrisons takeover not emerged and created uncertainty about the business-critical wholesale and franchise agreements, then investors would have stuck with McColl’s and remained confident that the prospective returns of investing in the ‘Morrisons Daily’ conversion strategy was worth the dilution of a share placing. I expect that the placing itself would also have gotten away at a far more attractive price per share.

I expect that the Morrisons wholesale and franchise deals will remain secure even after Morrisons is taken over, and perhaps in time we might even see Morrisons confirm this in a public statement. That would be a boon for the McColl’s share price. The combination of events and timing has stymied the momentum of McColl’s, but I believe the company is coming out on the other side and that from now on, the only way is up for the share price.

I expect that an investment would appreciate by at least 50% during the next 12 months, with the post-Christmas trading update being a key driver of better investor sentiment.

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The stock was trading at a near high of £34.89 by the end of the day on 6 August but dropped by 16% to £29.15 at the start of trading on 9 August. It’s now down 14% year-on-year. 

McColl’s plan for capital funding

McColl’s, which operates 1,200 local convenience stores and newsagents across the UK, started out as a cigarette vending machine maker in 1973. It listed in 2014. Back in March, it stated it had come to an agreement to extend its partnership with Morrisons by three years. This meant its partnership would now last until 2027. CEO Jonathan Miller stated in March that: “The agreement represents a significant milestone in McColl’s strategic goal of becoming a food-led convenience retailer.“

Its recent plan for a £30m cash call will require additional equity financing. The recent drop in the McColl’s share price has followed this news. That’s perhaps due to worries over share dilution in the near future.

The cash call will require a shareholder vote of approval due to McColl’s £40m market capitalisation. However, there has been no final decision over whether the capital raise will go ahead.

Assuming it does go ahead, it’s believed that CEO Miller will be providing an amount adding up to seven figures to help subsidise the capital funding.

The company has said that the funding will also be used to make its balance sheet healthier. It had reported a total of £89.4m in net debt in its FY20 report.

Growth for local convivence retail

As part of its Morrisons deal, McColl’s will be converting a large number of its stores into Morrison Daily stores. The company said its existing Morrisons stores are its top-performers.  

Angus Porter, the McColl’s chairman, has expressed his enthusiasm about the growth of local convenience stores. “Demand for our local convenience retail offering has never been higher, highlighted by like-for-like revenue growth of 12% during the year,” he said. And he emphasised the importance of local convenience stores due to the restrictions during the pandemic.

Bidding war for Morrisons

McColl’s has told investors that the intensive bidding war currently going on for Morrisons will not affect its partnership with the supermarkets giant. 

Private equity firm Clayton, Dubilier & Rice (CD&R), and Fortress Investment Group have both raised (or are reportedly planning to raise) their bids for a takeover of Morrisons. The current offer from Fortress stands at £6.7bn and while the board is supporting that bid, Morrisons has delayed the date for a shareholder vote so it’s not yet a done deal. 

Financially, Morrisons showed a good sales performance in its FY21 Q1 report. Total sales were up 5.3% with online sales up by 113%. 

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Food retailers have, historically, been considered ‘safe as houses’ investments. We still need to eat and drink whatever the weather, right? And so sales at grocery retailers don’t tend to crash, irrespective of how tough economic conditions are.

However, the increasing fragmentation of the grocery sector poses huge risks for McColl’s. And they’ve grown significantly following Aldi’s decision to launch an online grocery operation with Deliveroo.

This represents a big problem for the likes of McColl’s as it seriously undermines its modus operandi. Convenience. Aldi’s new service could allow shoppers to receive scores of own-branded goods within 30 minutes of placing their order. Things don’t get much more convenient than that, surely?

Competitive pressures

Okay, Aldi’s new service is small in scale and operates from around half a dozen stores. But it could prove a huge money spinner for the German chain and another significant problem for physical-only retailers like McColl’s, should it take off. It seems though, all those who operate an online service stand to gain significantly following the coronavirus outbreak.

Citing a report from Ensono, information technology bible Computing recently reported that 22% of shoppers who hadn’t bought online before lockdown are now doing so. Chillingly for the likes of McColl’s, the study suggests the proportion of consumers doing at least half of their grocery shop online looks set to rise from below 20% to north of 30%.

This particular chain also stands to lose out to the larger operators like Tesco, Aldi et al because of their ability to offer bigger discounts to cash-strapped consumers.

The 2008/2009 banking crisis proved to be a landmark moment for the German discounters as difficult economic conditions forced them to try and stretch their shopping budgets that little bit further. And the shocking recession that’s coming down the tracks promises to boost trade at those offering their goods for less once again.

Thus, McColl’s will need to remain engaged in massive, profits-damaging discounting to stop sales crashing through the floor.

Up 200% since the stock market crash

McColl’s shares are cheap. At current prices, it trades on a forward price-to-earnings (P/E) ratio of 6 times. This is well inside the broadly-considered bargain watermark of 10 times and below. But it’s a reading that reflects the rising threat to its operations — in both the current fiscal year and beyond — from its competitors’ physical stores and online services.

McColl’s share price has exploded since the stock market crash. It’s risen more than 200% from mid-March’s record lows of around 15p per share. I won’t be buying the grocery retailer’s shares though.

The fact its value has fallen by more than four-fifths during the past two years illustrates the huge risks posed by the increasingly-competitive landscape. This is a share which I fully expect to resume its downward trend. Sooner rather than later.

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Data released this week from the Society of Motor Manufacturers and Traders (SMMT) underlined just how difficult conditions were for the country’s car retailers last year. Just 2.3m new cars hit the road in 2019, down 2.4% year on year and the lowest number for six years.

However that same release suggested that conditions have improved more recently, the SMMT noting that there were 3.4% new units sold in December versus the same month in 2018. Could now be the time to buy into Lookers, then?

Time to buy?

The motor dealer certainly looks compelling on paper. City brokers are forecasting that the business will bounce back from another profits drop in 2019 with a 16% rise in the newly-minted year.

This leaves the small cap dealing on a bargain-basement price-to-earnings growth (or PEG) multiple of 1. However, it’s not just growth and value investors who might be tempted by the auto retailer as a forward dividend yield of 4.2% gives income chasers plenty to cheer too, a reading that beats up the corresponding average of 3.3% for the UK’s mid-caps.

In my view, though, Lookers is a risk too far, despite these compelling readings. The prospect of sustained political and economic uncertainty through to the end of 2020 at least, allied with ongoing pressures on the diesel market, makes it difficult to envision a profits rebound any time soon, at least in my mind. I think it’s a share that’s still best avoided.

9% dividend yields!

Could McColl’s Retail Group (LSE: MCLS) be a better destination for your cash today? It would seem a logical assumption as spending on groceries during difficult economic times always holds up better than expenditure on big-ticket items like cars.

In fact, convenience store operator McColl’s seems to be a superior stock pick in plenty of respects. Predicted earnings growth for the current financial year (to November 2020) comes in at a giant 19%, resulting in a rock-bottom P/E ratio of 6.2 times.

What’s more, City analysts expect annual dividends at the groceries play to keep ripping higher. Thus the forward yield rings in at a whopping 9%.

More shaky data

In my opinion, though, McColl’s still remains an unattractive pick right now as food shoppers keep a tight lid on spending and intense competition increases the top-line strain.

These themes were evident in latest trading numbers from Morrisons today. Like-for-like sales were down 1.7% in the 22 weeks to January 5, the FTSE 100 firm declaring that “trading conditions remained challenging and the customer uncertainty of the last year was sustained.” Incidentally, Morrisons said that wholesale revenues were dented because of weak sales at McColls in the period, adding to the intense sales pressure felt by its supermarkets.

McColl’s is cheap, but it’s cheap for a reason, its share price dropping 32% in 2019. And I reckon the prospect of more painful drops this year makes it another stock that’s best avoided.

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That said, I’m not tempted for even a second to splash the cash on McColl’s Retail Group (LSE: MCLS) despite some truly cracking earnings and dividend projections. And here’s why.

A 16% profits rise is forecasted for the fiscal year to November 2020, one which supports predictions the convenience store operator will start lifting dividends again. A 4.25p per share reward is anticipated, up from 4p in recent years, and one which yields a monster 10.7%.

I’m afraid these City estimates are looking just a little toppy, though. But don’t just take my word for it. The full-year results unveiled by McColl’s earlier on Tuesday reveal just how frothy these numbers look as trading worsens moving into the new financial year.

Like-for-like sales were flat in the fiscal period just passed, an improvement from the prior year when corresponding revenues dropped 1.4%, but hardly a signal of an impending turnaround.

Indeed, the retail play said full-year adjusted EBITDA would fall short of expectations due to “softer market conditions in the second half” because of lower consumer confidence and the impact of bad weather.

The high probability of current forecasts being blown off course mean not even a forward P/E ratio of 5.5 times — a reading which sits well inside the widely-regarded bargain benchmark of 10 times and below — is enough to encourage me to invest.

McColl’s continues to see its shares haemorrhage value (down 28% so far in 2019 and around 80% in the past three years), and there’s no signs the fallen retail play is about to turn things around any time soon. Expect more heavy stock price weakness in 2020, I say.

I’d buy this near-9% yield instead!

Those investors on the hunt for monster dividends (who isn’t?) would be much better off using their hard-earned cash to buy shares in PayPoint (LSE: PAY).

Sure, the tech play doesn’t offer the same sort of value as McColl’s, but a dividend yield of 8.6% for the current fiscal year (to March 2020) clearly isn’t to be sniffed at. Nor is a corresponding P/E multiple of 14.9 times.

Indeed, I’d consider this to be great value given the encouraging rate at which its Paypoint One retail terminals are being adopted by convenience stores the length and breadth of the country.

The number of sites operating these terminals, which do everything from stock management and parcel transit to taking payments from customers, surged by 2,207 in the six months to September to stand at 15,088.

So impressive has the uptake been that its full-year rollout target has been turbocharged to 16,500, from 15,800 previously, and therefore there’s plenty of reason to expect service revenues (which rose 32% in the half year to September) to keep on ballooning.

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Indeed, City analysts expect the company’s earnings per share will fall 15% this year. On the other hand, analysts have pencilled in earnings growth of 5% and 25% for Sainsbury’s largest peers, Tesco and Morrisons, respectively. 

Falling sales

It looks as if the company is closing in on analysts’ dismal expectations for the year. Sainsbury’s like-for-like sales for 16 weeks to the end of June were down 1.6%, excluding fuel, which tells me the business is struggling to compete in the current retail environment. And now that the group’s merger with Asda has been scrapped, it’s difficult to see what the future holds for this retailer.

Management needs to pull something out of the hat to return the business to growth and draw customers back into Sainsbury’s store. Until there’s some progress on this front, I’m not tempted by the firm’s low valuation and a 1.5% dividend yield. 

A better buy

In my opinion, a better retail sector buy is the convenience store operator McColl’s Retail (LSE: MCLS).  Even though it has its own problems, McColl’s has a plan. For the past two years, the group’s operations have been disrupted by supply chain issues, which caused profits to drop 50% in 2018.

While analysts expect a further decline of 15% in earnings per share for 2019, as the business continues to invest in growth, costs are coming down and sales are going up. McColl’s interim numbers for the 26-week period ending 26 May show a 1% increase in like-for-like sales and a decline in adjusted administrative expenses as a percentage of revenue of 0.3% to 25.2%. Adjusted EBITDA and profit before tax came in at £13m and £0.2m, respectively.

As part of its plan to rekindle growth, McColl’s management is working closely with Morrisons to offer customers a broader range of products at a lower price. The group is also trialling a “Morrisons Daily” format at 10 stores.

A more significant range and lower prices aren’t management’s only growth initiatives. The business is also rapidly reshaping its store estate. Some 41 underperforming stores and newsagents and smaller convenience stores were divested during the first half of this year while three new convenience stores were opened.

Growth returns

All of these efforts should, the City believes, help the company return to growth in 2020. With this being the case, I think the stock is a steal today trading at just nine times forward earnings. This makes McColls the cheapest the stock in the UK food and drug retailing industry. On top of this appealing valuation, McColl’s supports a dividend yield of 5.8%, so you’ll be paid to wait for earnings to recover.

So overall, if you’re looking for an undervalued retailer to add to your portfolio, I highly recommend taking a closer look at McColl’s. As the company’s growth initiatives begin to yield results over the next few years, the shares could rise substantially from current levels.

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Could it be argued though, that now is actually a great time to plough into McColl’s again? Some would see its forward P/E ratio of 8.8 times as low enough to reflect any more trading turbulence that might well come its way. Income hunters may see its jumbo 5.7% corresponding dividend yield as a reason to pile in too.

Reasons to be cheerful

But there’s no sugar coating it. Sales at the convenience store giant have been in the doldrums in recent years because of those aforementioned structural and cyclical problems, not to mention the collapse of supplier Palmer & Harvey two years ago.

Glass-half-full investors would suggest the business may be showing green shoots of recovery — like-for-like sales grew of 1.2% in the first 11 weeks of the fiscal year beginning December 2018, improving from flat growth in the prior quarter. McColl’s seems to be coming through the gloom created by the aforementioned collapse of its rival, while steps to improve key product lines, such as fresh food, also appear to be paying off.

What’s got many in the market quite excited is the steps the grocery play is making to boost its relationship with industry colossus Morrisons. Since the latter became the supply partner in 2017, the tie-up has steadily evolved, with McColl’s becoming exclusive stockist of the FTSE 100 firm’s Safeway-branded products.

And, more recently, McColl’s rebranded 10 of its stores under the Morrisons Daily fascia, a move which analysts at Peel Hunt said could make “a major difference” to the top line. Indeed, the broker suggested the decision to sell Morrisons-labelled products under the company’s branding could be “gold dust” to its smaller rival and prompt an extension of the programme to other stores in its estate.

Fresh financials coming up

Sceptics would argue Peel Hunt may be overestimating the possible impact of the tie-up in the wider scheme of things. It’s true the convenience segment continues to grow ahead of the broader grocery market, but the country’s Big Four operators still expanding their own operations here too. Just this month, Tesco announced plans to introduce upmarket stores stocking its Finest premium ranges.

Allied with the threat posed by the growth of the online and discount segments, McColl’s has a hell of a fight to keep its recent sales recovery rolling, in my opinion.

Now half-year financials are set to be released on July 23, but I’m still content to avoid the business. I’m not just fearful over the competitive pressures on McColl’s long-term profits outlook. I’m also concerned about how the rising pressure on consumer confidence will be reflected in that upcoming release. And for this reason, I think the retailer is in danger of resuming its shocking share price downtrend.

So ignore those big yields and low earnings multiples, I say. Instead, go shopping elsewhere for chubby dividends.

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McColl’s Retail (LSE: MCLS) is a newsagent and convenience store that stocks everything from your daily food shop to alcohol. The company has had a turbulent recent history with its key supplier, Palmer & Harvey, collapsing in 2018. This collapse left McColl’s stock levels incredibly low which wasn’t the best news for the company.

Good things on the horizon

However, it seems that it is already bouncing back from the 2018 disaster. The shares are up 70% to 83p in comparison to their low of 50.6p in late 2018. Thankfully, McColl’s worked quickly to pick things back up after Palmer & Harvey collapsed. By August last year, Morrisons was its new wholesale and distribution partner, rectifying any damage that had been done.

This obviously was not enough for the firm to avoid a profits hit in 2018, but 2019 has already seen the company on much firmer footing than before. The Institute of Grocery Distribution forecasts a 3.3% growth rate for convenience stores, which applies to 81% of McColl’s locations. Furthermore, the company is investing in 20-30 store revamps this year, predicting sales growth of 5% in these particular shops.

Coming up with solutions

It hasn’t just stopped there though. The company is also taking a look at its existing products and bringing in much more profitable ranges. There is a gradual long-term decline in news and tobacco that McColl’s is mitigating by introducing a new food-to-go range that should help to bring in new shoppers, as well as appealing to existing customers.

The company is clearly working hard to turn things around and I feel that the steps it is taking all make good commercial sense. With a reliable new supplier and new additions to the in-store offer, footfall should get a boost

Not plain sailing

That is all very well, but this does not mean that growth is going to be easy. The convenience store sector is very competitive and rising costs such as wages and rent will not make it a breeze for the company to bounce back.

Having said this, at such a low price of around 83p at the time of writing with a very healthy dividend yield of 4.6%, the risks appear to be priced in. I’m excited to see what the future holds for the company and I still have faith that McColl’s will continue to grow despite cynical investors.

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Down 75% over the past year alone, the convenience store operator has suffered because of intense competition, broader pressure on UK consumers’ shopping power, and supply chain problems related to the collapse of wholesaler Palmer & Harvey’s in late 2017.

Surprisingly, though, investor appetite for McColl’s perked up following full-year results released last week. In this release the retailer disclosed that, although like-for-like sales had slid 1.4% in the 12 months to November, its top line had made some positive progress as the year progressed, resulting in flat like-for-like sales in the final quarter.

And promisingly it was advised that underlying sales had actually perked up in the first three months of the new fiscal year, up 1.2% to be exact.

In recovery?

So is now the time to pile in, then? Not by a long chalk, in my opinion. Sure, City analysts may be predicting an 18% profits bounceback in fiscal 2019, aided by the completed implementation of Morrisons as its supplier in 1,300-odd of its stores. I fear, though, that increasing competition in the British grocery sector and the subsequent price wars threaten to blow this forecast way off course.

Not even its cheap share price, as illustrated by its rock-bottom forward P/E ratio of 7.2 times, is enough to tempt me to invest. Chief executive Jonathan Miller claimed last month that “in approaching 30 years in the business I have never known a year as challenging as 2018.” Those wholesaler issues may be consigned to history but there are still plenty of fearsome obstacles that McColl’s must overcome to return to earnings growth.

The convenience store segment, like online, is a rare bright light for Britain’s so-called Big Four supermarkets as sales in their traditional megastores have slumped. With sales here still growing it’s unlikely that the likes of Tesco and Sainsbury’s will dial back their assault on the sector.

Other risks

Rising competition from the country’s traditional grocery heavyweights is not the only cause for concern, though, as Amazon prepares to launch its own convenience proposition on these shores. According to media reports, the US internet giant has snapped up retail space in Central London in order to roll out its Amazon Go cashierless stores. 

McColl’s is also likely to suffer indirectly from the electric expansion plans of Aldi and Lidl, and particularly so as the tough economic environment encourages more and more cash-strapped shoppers into the arms of the discounters.

In a reflection of last year’s trading troubles McColl’s chopped the dividend back from 10.3p per share in the previous year to 4p, and City analysts are expecting a similar full-year reward to fiscal 2019 for the current period. Those increasingly tough trading conditions concern me, though, and therefore I’m wary of additional dividend cuts. For this reason I’m happy to avoid the company, despite its 7% forward yield, and invest my hard-earned investment cash elsewhere.

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That’s why I’m recommending FTSE 100 retailer Morrisons (LSE: MRW) as a better buy for your portfolio than buy-to-let property.

Best of the bunch

Morrisons isn’t the largest supermarket retailer in the UK, but it stands out to me for several reasons. 

First of all, unlike so many other retail groups, the company owns the freehold on the majority of its properties. This means Morrisons has a robust and asset-rich balance sheet. Management has also emphasised debt reduction in recent years. Net debt has declined from nearly £3bn in 2014 to around £1bn today, a level that seems sustainable because the group has more than £8bn of fixed assets.

Cash generation is another attractive feature of this business. Unlike many of its retail sector peers, its large freehold property portfolio means that Morrisons saves hundreds of millions of pounds in rent every year. Reduced costs mean the company is highly cash generative. For the financial year ending February 2018, the group generated free cash flow from operations after capital spending of £244m, easily covering the total dividend cost of £129m and the remainder was used to pay down debt.

Even though the stock’s current dividend yield isn’t that attractive (it sits at 3.6% today) the qualities outlined above suggest to meet that this company could be a tremendous long-term income buy for your portfolio. I expect the payout to rise substantially in the years ahead as the group switches from debt reduction to shareholder capital returns.

One to avoid

Morrisons’ dividend outlook is only improving, but one company that’s struggling to meet its obligations to investors is McColl’s Retail (LSE: MCLS). Today, the convenience store chain announced that for the year ended November 25, pre-tax profit slumped to £7.9m from £18.4m a year ago, even though revenue increased 8.1% year-on-year.

Rising costs were the group’s biggest problem. Administrative expenses increased 9.6% and finance costs surged 19%. Unfortunately, management doesn’t expect trading to improve substantially in 2019. Today, the company told investors that it expects a “modest improvement” in year-on-year adjusted EBITDA for 2019. The firm reported adjusted EBITDA of £35m for fiscal 2018.

With profits falling and no turnaround expected in the near term, management has decided to slash McColl’s dividend payout. The retailer proposed a final dividend of 0.6p, giving a full-year payout of just 4p. That’s down 61% from last year’s total payout of 10.3p.

What’s curious about this reduction is the fact that in its earnings release, McColl’s reported a “material” (31%) decline in net debt for the year to the end of November, and a 15% jump in net cash generated from operating activities during the period. 

So, even though the group’s financial position is improving, management has decided to reduce shareholder distributions. With this being the case, I would avoid the business for the time being, until its outlook improves.

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