Morrisons investors are hungry for more

After a painful couple of years, 2016 has heralded an almighty swing in sentiment for the supermarkets. Although competition is still high and industry headwinds remain, Morrisons has leapt 46%. Visibility hasn't improved, however, and there are now concerns the supermarket is too expensive ahead of final results on Thursday.

The shares have had an outstanding start to the year, rocketing by nearly half in the first two months of 2016. They hit a one-year high at 210p this week compared with under 140p in December.  

Morrisons' shares have outperformed Tesco and Sainsbury's by miles, too. Tesco is up 40%, while Sainsbury's is way behind, up just 7%, held back by its attempt to buy Argos-owner Home Retail Group.

After surprising the market with positive like-for-like Christmas sales, faster-than-expected net debt reduction and delivery agreements with Amazon's UK online grocery business and Ocado, much of the rerating is justified in Barclays' eyes.

Morrisons has won promotion back to the FTSE 100 index, too, after being kicked out in December, but, ahead of full-year results on 10 March, Barclays does have concerns.

"While it is undoubtedly better to be (at least partly) on Amazon's side rather than a direct competitor - and all volume through Morrison's manufacturing business is helpful in offsetting operational deleverage - we question whether the supply contract is especially material," explains analyst James Anstead.

"As a very rough estimate, we struggle to see how it could amount to more than 1.5% of Morrison's sales on a three-year view - it might just about replace the volume lost from the stores that have been shut or sold."

While Asda's "Project Renewal" is unlikely to reverse recent market share losses with any immediate effect, the shrinking of like-for-like sales is unlikely to continue for much longer, either. With such an overlap between the pair - both have over 45% of their space in the North of England/Scotland - Morrisons could suffer as Asda strengthens.

This year's knock-out free cash flow generation growth rate is also at risk, given that working capital inflows are hard to sustain and its surplus assets earmarked for disposal are diminishing.

A minimum 5p full-year dividend could be given a boost - but the future payout policy will be of more interestExpecting flat like-for-like fourth-quarter sales, Anstead reckons sales will have slipped 4.2% to £16.1 billion in the 52 weeks to 31 January, with cash earnings of £789 million up 4.9%.

Operating profit defined by Morrisons is set to slump 22.4% to £343 million and pre-tax profit to crash by over a quarter to £305 million.

In line with Barclays' definition, operating profit will rise 2.5% to £403 million, boosted by store closures. Morrison's' definition excludes £60 million of exceptional costs.

After recent company guidance pencilled in net debt of £1.65-1.8 billion and underlying pre-tax profit of £295-310 million, the market should have little room to be surprised on Thursday. However, a minimum 5p full-year dividend could be given a boost after strong cash generation - although the future payout policy will be of more interest. 

Although investors can look forward to getting more colour on Morrisons' £2 billion cash flow generation progress, cost savings and the living wage impact, Anstead is sceptical.

"We struggle to see Morrison as anything other than expensive, with the stock now trading on 18x 2017/18 consensus earnings per share - and 14x the level for which management would receive their maximum long-term incentive plan reward.

"While Tesco is admittedly trading on a similar multiple for 2017/18, that company arguably has greater margin rebound potential, has a clear scale advantage in the UK and has an international business.

"For these reasons we reiterate our 'underweight' recommendation on Morrison - although we do not necessarily see this Thursday's results as being a particularly negative trigger." 

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.