Morrisons tumbles despite profits surge

At a time when rivals Tesco and Sainsbury's have been busy filling their shopping trolleys with big-ticket purchases — Booker and Argos respectively — Morrisons has been quietly going about its daily business.

The fruits of its labours were on show for investors to see Thursday when the supermarket chain reported its first year of positive like-for-like sales and underlying profits growth since 2011/12.

Shares, which languished at 140p in December 2015 amid fierce competition from the German discounters, have rallied by 75% since then to restore Morrisons' place within the FTSE 100 Index. In contrast, shares in Tesco and Sainsbury's have struggled to gain any momentum.

The recovery of the Bradford-based chain is testament to the work put in by chief executive David Potts, who joined Morrisons in March 2015 having worked at Tesco for 39 years from the age of 16.

He insists Morrisons is still in the fix phase of its Fix, Rebuild and Grow strategy. There are six business priorities, which range from being more competitive for customers to simplifying and speeding up the organisation.

New partnerships with Amazon, Ocado, Timpson, Rontec, and the revival of the Safeway brand have all been capital light growth opportunities.

The company's trading progress was confirmed earlier this week by Kantar Worldpanel, which said Morrisons was growing faster than the rest of the sector following a 2.6% sales increase — keeping its market share at 10.6%.

In today's annual results, like-for-like sales were up 1.7%, after positive performances in all four quarters, including 2.5% growth in Q4.

Turnover rose 1.2% to £16.3 billion despite store closures, and underlying profits were at the top end of recent guidance after rising by 11.6% to £337 million. Net debt reduced by £552 million to £1.19 billion and is expected to fall below £1 billion by the end of this financial year.

The question now is whether Potts will be able to sustain the improvement. As with any turnaround story, it's possible that he has just been successful in picking the low hanging fruit.

Indeed, this fear was reflected in a 4% fall in the share price today. Such jitters weren't helped by a deterioration in one of Morrisons' key performance indicators, with a 5.4% decline in items per basket in the second half of the financial year. This was offset by a 4.3% rise in the number of transactions.

The company admits there are plenty of uncertainties ahead, especially the impact on imported food prices if sterling stays at lower levels. There is already evidence that rising inflation is affecting shopper's behaviour.

Morrisons also expects depreciation and pension costs to increase, although these factors and higher pay rates for staff are incorporated into its planning.

Chairman Andrew Higginson - another former Tesco executive - is confident the company will be able to drive sustained dividend growth and improving returns for Morrisons shareholders.

In the first year of a new dividend policy, today's proposed payout of 3.85p meant a full year total dividend up 8.6% to 5.43p. The divi is covered around two times by underlying EPS.

Shore Capital retail analyst Clive Black said dividends were visible and sustainable, given that they should be well covered by free cash generation.

He added: "All in all, the investment narrative and thesis around Morrisons is radically different, dramatically better and wholly more positive.

"The share has performed well over the last year, which is pleasing to record and so may lead to a period of understandable consolidation.

"However, we are reminded of still high level of shorting activity, which we sense needs to still unwind in due course, whilst a self-improvement and advancement of the investment story has most definitively not reached the end of the line in our view; in fact it is still rather close to departure hall."

ShoreCap has not issued a recommendation as it acts as broker to Morrisons. Among other brokers, Jefferies has a 'hold' recommendation and price target of 250p, while Bernstein's rating is 'market perform' at 210p.

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.