Is Morrisons worth bagging ahead of the half-year results?

With the half-year to end July now over, the Wm. Morrison share price (192p last seen) has behaved robustly. The company which a year ago looked too highly geared and devoid of ideas seems to have put its house in order. Morrisons has found its own way back to hope and credibility. The shares strike me as attractive ahead of the half-year results.

As Miss Marple might have said to the vicar over a china cup of Darjeeling and a corpse in the study, ‘Now, Vicar, everyone likes a little mystery in life!’

Shares of William Morrison (LON:WRM), that well known, down to earth Yorkshire food retailer, are having a good time. The mystery is why, given the state of things in the food retail sector under the assault of those cut-throat, cut price invaders, Lidl and Aldi.

In post-Brexit Britain, food retailers like Wm. Morrison are under the lash of these merciless discounters. These interlopers initially had the great advantage of little market share to lose and much to gain. As they managed to take market share from established British retailers like Morrisons, Asda, Sainsbury and Tesco, the scales of economy worked to the discounters’ advantage. Conversely, they worked to the disadvantage of the established companies who lost it.

Consequently, maintaining the scale of market share became crucial even at the expense of earnings and dividends. It was, apparently, short-term pain suffered in order to ensure not only long-term profits but also the long-term operating value and logic.

Understandably, the large long-term UK institutional investors with assets  locked up in the long established UK retailers were pretty much obliged to go along with defensive strategies to slash dividends and forgo net profits, in order to reduce prices for customers even if that meant lower operating and net margins (or none at all) in the short term.

This has not been a blind reaction but defensive strategy. Consequently, “investing in customers” became the imperative. This was now less of a euphemism and more of a hard fact of commercial life as the established operators transferred finances from capital providers to customers and lower prices became a dominant market demand that then ‘morphed’ into a fashion. Newspapers carried stories of Jags and BMWs in the car parks of the discounters; the thought of the affluent buying their shopping at discount stores became a kind of banking crisis – poverty chic. The alternative was for shoppers who craved premium retail association, to judge by the relative success of the up market end of UK marketing at M&S and Waitrose. Meanwhile, the hard times endured by the ‘big four’, of which Tesco was arguably the emblem, went on and on.

Although I am pleased to say that I saw fundamental undiscounted value in Morrison shares when I put pen to paper last January, when the shares were a mere 167p, I now wonder why Morrison shares remain fairly buoyant given that they are clearly vulnerable to the UK’s domestic post-Brexit consumer demand downside. Instead of plunging, the Morrison share price has been resilient. Since the June Brexit vote, when the share price fell from around 190p to near 170p, the share price has bounced back to just over 192p – the highest price in over a month. Moreover, the Tesco share price has declined by about as much as Wm. Morrison has risen and Sainsbury, although doing better than Tesco, is also lagging the Yorkshire grocer.

The chart shows Morrison shares as trending up with arguable support not far below this level (192p last seen) at around 182p.

My view in relation to the mystery of the share price strength is as follows:

• First, that the new CEO is doing a good job in finding a clearer identity for Morrisons, largely through re-discovering the older one that got lost. The business image has reverted to its gritty Yorkshire origins in advertising and marketing differentiation.
• From my personal experience, I note that Morrisons stores now seem enticingly well laid out, with green grocery and fruit laid out as if in an open market somewhere in Yorkshire, like Skipton. In short, this represents its competition with the M&S and Waitrose marketing signals of quality.
• The wholesale deal with Amazon (now renegotiated to Morrisons’ evident satisfaction) look entirely appropriate to the company’s financial needs and coherently related to the company’s product and marketing direction. It requires no big up front capital commitments; gives the management familiarity with online selling; and furthers the brand recognition of Morrisons fresh, ambient and frozen products on a now national basis. The margins may prove modest, but they should, one assumes, drop straight down to Morrisons’ bottom line in the case of Amazon and come at a seemingly reduced cost in the case of the Ocado joint venture.
• The company’s finances have also improved. Balance sheet cash as at end January 2016 more than doubled from the low level it reached a year earlier.  The company also tendered for outstanding loan notes in early June (some in Euros) with the objective of reducing balance sheet gearing which had already, in January this year, reduced by one fifth to an estimated 53 per cent of equity from a worrying 70 per cent a year earlier. The dynamic of less capital for expansion under the Amazon and Ocado deals and a lowering equity gearing ratio changes perceptions significantly.

The market consensus estimates for the current year include a 30 per cent increase in earnings, raising the forecast annual earnings to 10.16p and putting the shares on a prospective estimated price to earnings ratio of 18 times (twice covered) and a prospective estimated dividend yield of 2.7 per cent, which is forecast to rise to an estimated 3.1 per cent next year.