How to trade the supermarket sweep

In recent weeks, we’ve seen an array of bids coming in for British companies that others believe are undervalued. On Saturday, a bid came from US private equity firm Clayton, Dubilier & Rice (CD&R) with an unexpected offer for WM Morrison Supermarkets (MRW), for 230p a share in cash.

The company rejected this offer saying that the board “unanimously concluded that the conditional proposal significantly undervalued Morrisons and its future prospects”. Whilst this may be true, it’s also true that only a sucker accepts the first offer – unless the first offer is outrageously good you do all you can to get the buyer to put pen to paper before they get remorse.

What is interesting to me is that something so liquid as Morrisons at over £4bn market capitalisation can be so fundamentally mispriced according to others. What we also have to consider is whether the board are acting in favour of themselves or for shareholders.

When Sirius Minerals (SXX) was taken over by Anglo American (AAL) last year, many believed that management had recommended the offer because they got plum jobs and were looked after. If Anglo had put its own people in place – would management have come to the same conclusion and accepted the offer for shareholders?

As I wrote last week, the equity market trades on emotions and not efficient fundamentals. This week Sosandar (SOS) bosses awarded themselves a generous package of nil-cost options, because they can. This stinks in my opinion. Nil-cost is the simple transferring of cash from shareholders into management’s back pocket. Given that the “inspirational leadership” hasn’t exactly executed brilliantly so far, I fail to see how this is deserved. Nobody would complain if they awarded themselves a chunky slice of pie at much higher levels, as that would be rewarding success, rather than rewarding themselves for simply being there, but sadly this is endemic in the London market.

But back to Morrisons. Is this the private equity firm’s inflation trade? Wholesale prices will rise – the question is will the supermarkets be able to pass on these rises to the customer? We’ve been here before. Back in 2007 when the global financial crisis was raging on, the bosses of the big four were asleep at the wheel pushing prices higher and this pushed shoppers into the welcoming arms of Aldi. Private equity firms are often masters of financial wizardry. But they are not always right.

In any case, Chart 1 shows the opening auction extended until 08:05 and then the price coming screaming out of the blocks rallying from 228.5p to over 237p in the first 20 minutes of trading.

Despite the market having well over 24 hours to digest the deal there was still volatility on offer for traders. If you’re with IG then you would have been able to place an order in the auction. This is because IG’s prime broker, Citi, does not allow trades that are above a certain threshold or above or below the previous uncrossing trade. Morrisons was gapping up around 30 percent and so you would have had to call early and get your order in manually. This continuously catches me out, but I’m not aware of any solution. I can see why it’s done, as otherwise clients would be triggering intraday auctions all day along, but professional traders should have full access to the tools available. If I ever figure a workaround – I’ll let you know.

However, the unsolicited bid now potentially puts the rest of the sector in play. If one stock in a sector receives a bid then others can see a lift up in price as a read-across. Asda was acquired in February, and whilst Tesco (TSCO) was flat on the day with no reaction Sainsbury’s (SBRY) gapped up from 260p to an open of 270p. At £6bn market cap though, I feel it’s best to look smaller.

McColl’s (MCLS) is a sector minnow at £43m market cap. It’s also extremely high risk, given that net debt is £89.6m (or £282m if you look at the post-IFRS 16 number). Like-for-likes have grown 12 per cent but margins have taken a dent, pretty much seeing revenue flat at 3.2 per cent higher.

Chart 2 shows the price action on McColl’s since the end of 2019. The price is now trending upwards gently and is above the longer-term moving averages.

The price moved recently and spiked in March due to the new Morrisons partnership agreement which will see the acceleration of the Morrisons Daily format, with store conversions planned over three years. The bank facility has also been extended until February 2024.

I’m watching the top level of resistance on the chart of McColl’s, and it’s also on my watchlist for any news. McColl’s has been written off by many (and not without good reason) – but any material change in the business’s fundamentals will see a surge in price.

It pays to focus on smaller companies as these companies are often neglected and deemed too small. Smaller companies also move faster, because as Jim Slater once said “elephants don’t gallop”.

• Michael has started his Buy the Breakout newsletter which contains trading ideas and tips he has learned whilst trading. You can subscribe for free at his website here: www.shiftingshares.com/newsletter/
• Twitter: @shiftingshares
• New subscribers to SharePad can claim a free month of data with the code: Michael