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Morrisons offers income appeal

The supermarket's repeated special dividends are just part of the income story
November 14, 2019

Wm Morrisons (MRW) has come a long way since 2015, when then chief executive Dalton Philips resigned after reporting a 3.1 per cent decline in like-for-like sales excluding fuel over the Christmas period. The dividend was slashed shortly thereafter, to 5p from 13.7p the year before. Since then, an aggressive turnaround plan has been pursued by replacement chief executive David Potts, the former boss of Tesco's UK stores and Asia businesses. Costs have been cut and underperforming stores have been closed. Many were betting the strategy would fail – disclosed short positions against the shares peaked at more than 19 per cent in late 2016 and remain at 5.7 per cent. However, the group has recovered strongly, returning to growth and paying out successive special dividends. Now, with an attractive dividend case and a deepening partnership with online retail giant Amazon (US:AMZN), we think the shares warrant a second look.

IC TIP: Buy at 199p
Tip style
Income
Risk rating
Medium
Timescale
Long Term
Bull points

Attractive dividend
Robust trading
Amazon takeover speculation
Predominantly freehold stores

Bear points

Thin margins
Competitive market

The group sources and processes much of the fresh food it sells through its 494 supermarkets (two more to be opened this year) and online delivery service. It also has an extensive wholesale operation that serves companies from Amazon, to convenience store chain McColl's, to petrol station operator Harvest Energy. Revenues came in at £17.7bn in the year to February 2019, and management says the group’s wholesale operations are on track to reach a £1bn sales target in the current year.

Much has been made of the difficult retail environment, with the larger supermarkets – Morrisons included – continuing to lose share to discounters such as Aldi and Lidl and online retailers such as Ocado. Morrisons has held up reasonably well compared with the other big supermarkets, losing 1 per cent share since the beginning of 2017 to leave it with 9.9 per cent.

The group traded ahead of expectations over its first half and reported adjusted pre-tax profits up 5.3 per cent at £198m, in spite of the same period last year benefiting from the hot summer, the men’s football world cup and a royal wedding. First-half free cash flow strengthened by £15m to £244m, prompting the board to propose a special dividend of 2p – its fourth in the past two years.

Paying out additional dividends while the retail environment is so difficult may seem reckless, but Morrisons’ balance sheet looks broadly reassuring. The group’s property portfolio is 86 per cent freehold, which has protected it from having to report really massive liabilities related to the introduction of new lease accounting rules. Reporting leases as a balance sheet liability has led to a £1.4bn increase in net debt to £2.4bn, which compares with an increase of more than £10bn for Tesco and £5.8bn for Sainsbury. That said, it should be noted that during its recent turnaround cash flows have benefited to the tune of £1bn by stretching out payment terms with suppliers; trade creditors rose from £1.4bn to £2.4bn between February 2015 and February 2019. Working capital improvements of this kind are finite.

The group has been working with Amazon since 2016, providing wholesaling for the retail giant’s Prime, Fresh and Pantry online grocery offerings. The two recently expanded their partnership, and will offer same-day grocery delivery in at least five new cities, in addition to the four they currently operate in. Wholesale is only a small part of the overall business, but management hailed the new partnership as a “capital light growth opportunity” – what's more, it helps fuel longstanding speculation of an Amazon takeover.

Wm Morrison Supermarkets  (MRW)  
ORD PRICE:199pMARKET VALUE:£4.8bn 
TOUCH:198-199.5p12-MONTH HIGH:253pLOW:177p
FORWARD DIVIDEND YIELD:6.8%FORWARD PE RATIO:14 
NET ASSET VALUE:182pNET DEBT**:22% 
Year to 03 FebTurnover (£bn)Pre-tax profit (£m)*Earnings per share (p)*Dividend per share (p)
201716.333710.85.40
201816.936911.810.10
201917.740612.912.60
2020*17.841213.012.80
2021*18.345214.313.50
% change+3+10+10+5
Normal market size:7,500    
Beta:1.32    
*Shore Capital forecasts, adjusted PTP and EPS figures **Excludes lease liabilities of £1.4bn