Wm Morrison Supermarkets (MRW) is the fourth-largest U.K. supermarket chain with 10.8% share and strong market positions in the north of England and Scotland. Following a change of management, the company is in recovery mode, having lost a significant amount of market share in recent years – over 200 basis points since the start of the decade, mostly to the hard discounters. Same-store sales growth has been positive for five consecutive quarters now, and margins recovered in the year to January 2017, though they are still well below peaks reached earlier this decade.
We are cautious on the prospects for further recovery
The new management team has adopted a more practical approach, focusing the business on fresh produce while better managing the balance sheet and cash flows. Morrisons has squeezed working capital hard and sold off unwanted stores, generating over £1.72 billion in total.
However, we are cautious on the prospects for further recovery. Morrisons is hardly opening any new stores and is squeezed between the hard discounters and larger mainstream supermarket operators. We think underlying organic sales growth will struggle to reach even 2% while margins will only modestly recover and remain well below previous peak levels. Near term, sales and earnings could be bailed out by the depreciation of the British pound, which is likely to lead to higher inflation, but this will be temporary.
The United Kingdom's national minimum wage is set to increase 25% between now and April 2020, which could negatively affect operating margins by 150 basis points. Aside from being located in the less prosperous parts of the U.K., Morrisons mostly overlaps with the most price-competitive players, including Asda, Tesco and the variety or discount stores.
Management's own guidance for operating profit to benefit from a £50 million-£100 million boost from a combination of cost-saving and profit-enhancing initiatives looks decidedly unambitious, considering that operating profit dropped 65% – a decline of over £600 million – in the three years to January 2016. This corroborates our view that Morrisons will struggle to rebuild profitability and value destruction looks to be a more permanent feature of its business.
