Rethink supermarkets and start with Morrisons

After a month in which shares of many unloved stocks have soared, fueled by flash mob-like attentions from the Reddit forums, it’s a little strange to talk about the investment record for WM Morrison (MWR). Indeed, for several years, the share has been a favorite target of hedge funds, which means that at any time – at least in theory – it could benefit from a gamma compression.

Bullish points

Best sector strategy

Now an omnichannel company

Well capitalized

Market share gains

Long term income

bear dots

Food inflation risks

Low margins

But we’re going to make the supermarket business case anyway, and even after a year in which hopes of pandemic-driven revenue increases have been dashed by the added costs of dealing with Covid-19 . That’s because there’s a growing bull case for the broader grocery sector, after years of understandable investor apathy. Within the group, Morrisons seems to be a favorite.

We presented an income-themed long-term investment case four months before the pandemic managed to bring the UK economy to a halt, and with shares at 199p. Much of what we said then holds true now. A deep partnership with Amazon remains positive for sales, brand image, and ever-present takeover talks. A now profitable wholesale branch is going from strength to strength. And although the series of special dividends ended last year as cash management priorities changed, a strong balance sheet should support payouts.

Fifteen months later, we also believe there is further evidence that Morrisons has the right strategy. Its operations are not hampered by legacy bets in international markets, banking or non-food retail (unlike its rivals Tesco (TSCO) and J. Sainsbury’s (SBRY)), while expansion plans do not rely on sale-and-leaseback agreements and issuing billions of pounds of junk debt, (as with private equity Asda leveraged buyout). Limited-range discounters Aldi and Lidl remain a threat, although their deliberate underinvestment in online channels is now emerging as a weakness.

In contrast, Morrisons increased its market share from 9.9% at the end of 2019 to 10.4%, according to Kantar World Panel. This is a higher rate of increase than any of the UK’s Big Seven grocers (see chart), and is due to a combination of additional in-store and online capacity, the expanding link with Amazon, to home deliveries, to a range of popular food boxes. , and a successful trial with the Amazon Deliveroo-backed last-mile delivery group.

At the same time, sales for Morrisons and the wider sector have been boosted by the designation of grocers as essential retailers, although the return of £230m in commercial tariff relief and £280m in pounds of one-off virus-related costs in the recent financial year ended shows that this has been a double-edged sword. An unchanged forward price-to-sales ratio of 0.25 also suggests that investors view last year’s like-for-like trading rally (see chart) as a one-time event.

From deliveries to delivery

The short-term pessimism is not unfounded. The reopening of the hospitality industry could mean lower non-fuel retail sales for Morrisons in the 12 months to January 2022. This is not a given, however, and many people will have picked up new habits that will prove sticky. Similarly, we believe shareholders should think bigger and longer term.

Why so bullish? Well, in less than a year, the incumbent grocery industry has both improved its brand equity and learned a decade of lessons on how to successfully run and grow a grocery shopping business. line.

A little late perhaps, but supermarkets finally understand what Jack Ma meant when he told Alibaba shareholders that “the line between offline and online commerce is disappearing as we focus on satisfying customers. personalized needs of each client”. These comments were made in 2017, the same year that Amazon surprised everyone by buying the high-end supermarket chain Whole Foods.

Why would the most successful e-commerce company in the world value brick-and-mortar retail? As Boston-based investor Gavin Baker argue convincingly, physical retail operations help reduce the so-called customer acquisition cost (CAC) for online retailers, who are eternally looking (and often struggling) to improve their marketing effectiveness. “In a world where ‘CAC is the new rent’…one of the best ways to lower your online rent – ​​aka CAC – is to pay offline rent for physical stores,” says Baker. A real-world presence helps build customer loyalty online.

This brings other advantages. Morrisons is now offering a click-and-collect service, which is only expected to grow as customers cement the habits formed during lockdown, particularly if they have found them more convenient. The past year has also forced grocers to think intelligently and effectively about meeting and anticipating customer needs. So it’s encouraging to hear CEO David Potts talk about a rapid and continuous learning process. Partnering with Amazon, the perennial reinventor, can do little harm in this endeavor.

There is another reason to believe that the sector, and Morrisons in particular, appear undervalued in a post-Covid world. Although there are pockets of strong economic recovery in the UK, the return of restaurants and bars is likely to be both staggered and held back by the millions of people whose disposable incomes have been hit by job losses. or financial difficulties. It won’t be as binary as leisure stocks versus food retailer stocks, but the higher valuations of the former seem like an odd premium for the market to apply over the latter. We now know that unless there is a total social collapse, supermarkets will stay open.

Evolution, not revolution

Naturally, investors should always be alert to the negative aspects of the sector. Although bets against the stock at 3.9% are down from the post-Brexit vote of nearly 20%, Morrisons is still the 13th-shortest London-listed stock, according to regulatory filings.

This means that many smart people remain bearish and with foundations. On the one hand, while it’s fair to say that the worst fears have been averted, Brexit is creating all sorts of complications for UK food supply chains. These are not limited to customs issues either. After the withdrawal from the single market, the government still has to find a long-term solution to the agricultural labor issue, even if some believe the eventual settlement could lead to high prices on supermarket shelves.

With or without a home-grown supply chain, the growing prospect of higher inflation in the years to come will challenge a business model that keeps suppliers on a leash while giving customers everything they want. . Add to that fierce competition and you have an average operating margin of 1.9% over the past five years. The flip side could be an increased consumer preference for the lower prices that supermarkets specialize in. Plus, Morrisons has navigated inflation for over a century.

The current chapter in that long story sees the grocer finally begin to emerge as a digital, omnichannel business, with all the potential for productivity efficiencies that this brings. A professional pricing regime that levels the playing field for brick-and-mortar retail is another potential boost in the coming years. Property investors, unable to invest enough money in supermarket sites, seem to recognize the renewed strength in the sector. The rest of the market may also wake up soon. Morrisons annual figures are released on March 11.

Wm Morrison Supermarkets (MRW)
ORDER PRICE: 177p MARKET VALUE: £4.3 billion
TO TOUCH: 177-178p TOP OF 12 MONTHS: 210p MOOL: 158p
TERM DIVIDEND YIELD: 4.2% BEFORE PE RATIO: 12
NET ASSET VALUE: 185p NET DEBT: 63%*
Year at January 31 Turnover (in billions of pounds sterling) Profit before tax (£m)** Earnings per share (p)** Dividend per share (p)
2018 17.3 374 11.9 6.10
2019 17.7 396 12.6 6.60
2020 17.5 408 13.0 6.80
2021** 17.9 426 13.6 7.10
2022** 18.1 446 14.2 7:40 a.m.
% change +1 +5 +4 +4
NMS:
Beta: 0.2
*Includes lease liabilities of £1.4bn
** Berenberg forecast, adjusted PTP and EPS figures

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