Sunday, 13 March 2011

Morrison's Preliminary Results: "Different and Better than Ever"?

Morrison (Wm) Supermarkets @ 286p yielding 3.4% with the current full year 9.6p per share.

Well, Morrisons managed to beat market expectations with its preliminary results for the year ending 2011, and managed to further surprise on the upside with announcements on new developments.

Highlights include:
- Sales up by 6.9% to £16.479bn (y/e 2010: £15.410bn)
- 15 new stores opened with agreements in place to acquire 16 Netto stores
- Post tax profits up by 5.7% to £632m (y/e 2010: £598m). Pre-tax profits were only up by 1.9% due to an exceptional credit of £91m in the y/e 2010?
- Cash-flow per share of 33.79p comfortably in excess of adjusted earnings per share of 23.00p (the general view is that earnings per share, due to accruals etc, can be more easily manipulated than cash-flow so a prospective investor should be worried about cash drying up if eps is higher than cash-flow per share. For me higher cash-flows enable companies to minimise short term borrowings, overdrafts etc which can only boost profits.)
- Full year dividend increase of 17% to 9.6p, covered 2.4 times
- Interest payments have fallen to £30m (y/e 2010: £49m) and are well covered by pre-tax profits of £904m.
- Net debt down to £817m (y/e 2010: £924m), even after capital investment of £592m.

Elsewhere, less impressive figures include:
- cash balances decreased by £17m to £228m
- profit margins dipped to 5.49% (y/e 2010: 5.89%) 
- Inventory has jumped by 10.6% to £638m (y/e 2010: £577m)
- Return on Capital Employed dipped to 12.71% (y/e 2010: 13.49%) 

The results, announced on Thursday, saw the shares go up against the market albeit by a less that exciting 5.5p by close of play Friday but, any gain should be gratefully taken against the volatile storm of conflict and disaster that has stalked the market this week. 
I wouldn't hold my breath if the market continued to fall next week though as any good news will be quickly forgotten.

The new Chief Executive: Dalton Philips, is now in place though, and in the words of the non-exec Chairman: Sir Ian Gibson:
"our new CEO, arrived early in the year and quickly began to make his mark. He has shaped his senior management team with a great blend of new and existing talent, and between them they have developed a clear plan to deliver the next stage of Morrisons growth, with a vision to be 'Different and Better than Ever'".

So what clues do we have? 
Well, rumours have been in place for some time that Morrisons would like to offer an online service and this has been addressed on 2 fronts:
- 1: the £70m acquisition of Kiddicare, a specialist retailer of baby and infant products that is already successful and has strong online technology in place.
- 2: the surprise announcement of a £32m investment in FreshDirect, a profitable and fast growing online grocer serving a 600,000 New York customer base. Morrisons investment will gain it a 10% stake and a seat on the board but, more importantly, enable Morrisons to install a team to "learn the ropes" so to speak. The underlying business has been established and grown over 12 years with like for like sales growing at 20%.

This seems quite an innovative but prudent approach to understanding and establishing its own online offering but it remains a challenging market (albeit one that is still in its infancy) and has yet to show significant profits for other supermarkets.
In another sign of wanting to catch up, Morrisons has also announced trial branches of its convenience store format to be launched in July.

Whilst both of these strategies sound exciting (and I applaud Morrisons approach), I am slightly less than inspired that Morrisons is choosing to play catch up and it remains a valid question whether an online operation can satisfactorily add to a supermarkets sales and more importantly for shareholders', its profits. 
Surely, it can only be a  luxury service at this stage adding to the convenience of some customers so, for me, it is essential that costs are recovered.
In addition, the convenience store format increases margins on a smaller range of items but at what point do these margins become profitable to the outlet when set against the initial outlay and ongoing staffing costs?

Elsewhere, Morrisons has also pledged to increase the dividend by at least 10% a year for the next 3 years. 
Well done, but in the last few years the dividend has seen respective increases of 20%; 20.83%; and 41.38%; prior to this years 17%, so is this a fanfare statement or just a lowering of expectations? 
If it is the latter, then a clearer, more explanatory link to capital investment and the challenging environment should be made.

The announcement of a share buyback of £1bn raises further concerns. 
My initial reaction was one of disappointment as I have rarely experienced a share buyback and seen the black and white benefits initially envisaged. 
In theory, the direct result of a share buyback is less shares in issue. Annual profits are therefore divided between less shares which increases the earnings per share figure. The salesman's pitch being that the share price "should" increase to the same rating it was prior to the buyback but on a higher eps figure.
In reality, market environments change and not all things are equal so the expected capital gain never seems to come through.
In general, I find it takes a more fundamental shift in perception of a company's prospects to achieve a re-rating but then it is questionable whether it is the change in perception or the buyback that achieves this.
At one stage BP was buying back shares with all earnings in excess of an oil price of $35 per barrel, which was a lot of money being spent with little to show for it!

The cynical investor in me always feels cheated at this "lost/wasted" money as opposed to a straight forward special dividend which tangibly returns cash to shareholders and is therefore easily measurable.
For larger shareholders, a special dividend could incur a tax liability so a buyback is often sold to them on the basis of having greater tax advantages.
More cynically of me still, I fully expect that Directors performance bonuses are measured on EPS so by "borrowing" and spending money to buyback shares the EPS goes up and bonuses are paid....but at what short term cost to the balance sheet. 
The change in management, and the many new faces, makes the potential manipulation of these measures a valid concern until capability, results and loyalty has been demonstrated.

Companies normally announce share buybacks when they no longer see opportunities to invest in and therefore have "excess" cash. In which case, it is normal to return cash to shareholders. My personal choice, for multiple reasons, would be the tangible one of a special dividend. 
However, in this case, rather than a buyback I would prefer the company kept the money to support cash flow, reduce borrowings etc. 
In this way it would continue its traditionally prudent approach and maintain its financial and balance sheet strength during the declared difficult times ahead.
In his Chairman's statement, Sir Ian Gibson states:

"We expect the economic backdrop to remain challenging in 2011, with higher taxes, government spending cuts, inflation and rising unemployment all continuing to weigh on consumer confidence and disposable incomes."

...this being the case, and considering that the company is also accelerating a store growth program along with investments in trial formats, it seems financially naive of the company's management to "borrow" money to fund a share buyback. 
In the short term, the increase in liabilities weakens the balance sheet and the increased payments reduce profits. There is also little, or no, guarantee of a shareholder benefit; and it makes it more difficult to differentiate between organic growth and redistributed profit from share buybacks.

Increasing store space, a differentiation from other supermarkets, and the intention of increasing efficiencies are positives, as are investments in profitable businesses. 
A commitment to the dividend is welcome.
The company also has a strong balance sheet with the majority of its estate on freehold and gearing of 15%, and it may be that it is too tempting not to take advantage of this and be more "efficient" financially by "gearing up".
However, I am highly sceptical as to both the reasoning and the benefits of the share buyback particularly in the current climate and during an expansion program. 
What I would have preferred to see is: cancel the planned fund raising and give shareholders a commitment of 15%-20% annual growth in the dividend for the next 3 years ahead of the questionable 2 year share buyback.

Morrison shares are already in the virtual portfolio and there are still plenty of brokers' buy recommendations (based upon the buyback boosting earnings) but for me, a mixed bag and very much a work in progress with some concerns to keep an eye on. 

Morrison (Wm) Supermarkets @ 286p, goes ex dividend on the 11 May paying 8.37p per share.

Sir Ken's sell off!

In other news, I see that Sir Ken Morrison (the company's Life President and youngest son of the founder) has run afoul of the FSA by failing to declare the run down of his personal holding in Morrison which, since September 2009, has fallen from 6.07% to just 0.9%. 
The sell off has occurred in 4 stages all of which should have triggered a declaration by Sir Ken.

It could just be poor judgement on Sir Ken's part but does raise a concern about his motives!
This being that, although, the wider Morrison family continues to retain a 9% stake in the company, is this sale based upon valid concerns about the company, a valid personal reason, or just sour grapes from Sir Ken at his failure to "eat the elephant" and the subsequent fall-out which saw him eventually step down from the Chairman's position.

Hmmm, another unanswered question hanging over Morrisons!

Previous related posts:
Supermarket Sweep: Tesco; Morrisons; or Sainsburys?
Looking Ahead to 2011.

Related articles: Broker snap: Morrison's space expansion impresses Sir Ken Morrison share deals to spark FSA probe

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