Morrisons could be the winner in the battle of the supermarkets

4 mins. to read
Morrisons could be the winner in the battle of the supermarkets

Morrisons (LON: MRW) has enjoyed a superb Christmas trading period. The food retailer posted its best performance for seven years as it recorded LFL sales growth of 2.9% for the nine weeks to 1 January.

A key reason for this is the company’s strategy, with its focus on improving the customer experience, becoming more efficient and diversifying into faster growing spaces at a relatively low cost proving to be positive catalysts on its sales performance.

However, the UK food retail market is in the process of change, due mainly to Brexit. Food price deflation has been a key part of the industry since the Global Financial Crisis. Competition has been high and this has led to a downward spiral in the price of an average shopping basket.

But now that sterling is weak and could depreciate further, food prices are likely to start to rise as grocers pass on higher costs to consumers. In this new era, Morrisons has the right strategy in my view and could outperform its rivals.

A changing industry

It may feel as though Brexit has had a relatively minor impact on the food retail industry. The fall in the value of sterling has not yet been felt, since food price deflation stands at 2%.

However, this situation is set to change, with food prices expected to begin rising this year. In fact, by the fourth quarter of the year they are forecast to be rising at an annualised rate of 1.6% as higher import prices are passed on to customers.

…food prices are likely to start to rise as grocers pass on higher costs to consumers.

This would mark a significant shift for the industry. Since the credit crunch, the emergence of no-frills operators such as Aldi and Lidl has forced the supermarket majors to reduce prices.

Demand for lower prices has mostly been driven by consumers who have seen their disposable incomes come under pressure in real terms for much of the last decade. However, shoppers must now contend with a situation where food prices are rising and their wages are not going up by a significantly greater amount.

The right strategy

In such an environment, I believe that the right strategy is to focus on non-price differentiation and efficiency. That’s because it will be extremely challenging for food retailers to absorb higher import prices over the medium term.
food retailers will almost inevitably pass a large part of the increase in import prices on to consumers. This means they must find a means of retaining customers and attracting new ones, while also seeking out new growth areas through which to increase their sales and profitability.

Similarly, generating efficiencies is also likely to be of high importance in 2017. Supermarkets which are able to do so could potentially absorb higher import costs to a greater extent than their rivals, which may make them more competitive. Further, an improving balance sheet could be beneficial as investment may be required in order to generate efficiencies.

The Morrisons way

As mentioned, Morrisons enjoyed a strong Christmas trading period. In my view, it will continue to outperform its peers in 2017 as it has the right strategy to deal with what may prove to be a new era in food retailing.

For instance, Morrisons is investing heavily in improving the customer experience. It has focused on improving service standards including having more tills open to reduce queuing times and more staff members to provide help to customers on the shop floor. At a time when prices are forecast to rise, customers may value a better experience to a larger degree and this could help to improve customer loyalty towards Morrisons.

The company is also seeking to expand its operations into new growth areas which require relatively low initial investment. For instance, it has leveraged its status as a major food producer to supply Amazon’s online food retailing business, while resurrecting the Safeway brand which will include a range of products stocked in convenience stores. Additionally, Morrisons has introduced a ‘Best’ range of premium products which could help to broaden its appeal.

Morrisons is investing heavily in improving the customer experience.

Morrisons has also sought to shore up its balance sheet ahead of what may prove to be a challenging period for the industry. Its net debt is due to fall to £1.175 billion in the 2017 financial year, which would be a £594 million reduction from last year.

In addition, it is seeking to implement measures which improve its efficiency and cut costs. For example, it has introduced a new automated ordering system in recent months which uses store-specific historic sales data to forecast stock requirements. It is capital light, utilises cloud technology and reduces stock levels.

The right time to buy?

Since the outlook for the food retail sector is uncertain, Morrisons is a relatively risky buy in my opinion. The combination of rising food prices and potential difficulties ahead for the UK economy could mean that consumer spending growth disappoints. Since Morrisons has a P/E ratio of 23.2 and is expected to grow its EPS by 10% in the 2018 financial year, its shares do not appear to be cheap.

However, the company’s strategy should allow it to outperform the wider sector. Therefore, it still has investment appeal in my view.

At a time when the supermarket industry is set to enter a new era of rising prices as a result of weak sterling caused by Brexit, Morrisons could lead the pack. Its focus on reducing debt, becoming more efficient and offering an improved customer experience should provide a boost to its sales and profitability.

Similarly, diversifying its operations through the deal with Amazon, a premium product line and a convenience product line could invigorate its financial performance yet further.

Therefore, I believe that now is the right time to buy Morrisons for the long term, although its share price could experience a volatile year.

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