Morrison looks a mess

Its full-year results for 2012-13 make horrible reading. Same-store sales fell 2.1 per cent in 2012-13, translating into a 7 per cent fall in pre-tax profits. These unsavoury figures suggest that the grocer has not been able to tempt shoppers through the door, despite soft comparisons and the huge amounts of money - and time - Morrison has spent sprucing up its stores into so-called 'fresh formats', improving the products and developing convenience and multi-channel propositions.

Meanwhile, capital spending ballooned to over £1bn, a 13 per cent increase on the year, while net debt rose from £1.5bn to £2.2bn, largely to fund these investments. The supermarket says spending will rise further to £1.1bn in 2013-14, including £150m for multi-channel development. Yet this level of investment requires further borrowing, which could be bad news for investors. Clearly, Morrison can't maintain its present rate of capital spending and keep growing its dividend at 10 per cent a year, one of the few attractions of its shares. In 2012-13, it generated just £96m of 'free' cash (the cash left over for shareholders), but still paid £270m-worth of dividends and spent £514m buying back its own shares.

Broker Cantor Fitzgerald Europe expects return on capital in 2013-14 to fall to just 8.1 per cent and the operating margins to narrow to 4.9 per cent. "The underlying core supermarket profit is in retreat. Morrison continues to risk its trading margin trying to solve sales underperformance and lack of scale," says analyst Mike Dennis.

But overshadowing the poor results was news that Morrison is looking to strike a deal with online grocer Ocado to launch an online shopping service. It looks like a deal of the desperate. Ocado has never posted a pre-tax profit and needs throughput, and Morrison badly needs an online presence. Yet Morrison has a 10 per cent stake in successful New York-based online grocer Fresh Direct and has spent years and millions of pounds examining online grocery models. That just makes its choice of a partner in Ocado even stranger.

Chief executive Dalton Philips has had more than two years to introduce online shopping, so news that investors can't expect the service until 2014 is disappointing. Mr Philips argues that by arriving late, Morrison has learned from the mistakes of its rivals and will be able to run a better and more profitable online operation. Maybe.

Meanwhile, the rising cost of fuel means consumers are turning towards convenience stores. This market grew 5 per cent last year, is worth £35.6bn and is expected to grow faster than the traditional grocery market. Morrison has only just entered this lucrative arena with its 'M Local' chain, so there is potential for growth. A focus on London and the south east, where Morrison doesn't have a meaningful presence, is sensible, and it has bought 49 former Blockbuster and and six former HMV stores to expand the group's portfolio. The target is to have 100 M Local stores trading by the end of the year.

Morrison has also escaped the horse-meat scandal, which damaged the reputation of some competitors. Its vertically-integrated structure means it owns many of its own farms and abattoirs and can therefore guarantee the provenance of its food. That's good, although 'horsegate' may soon fade from consumers' memory, just as worries about mad-cow disease did.