Morrisons - Securing the hatches - Model Update
All,
Please see our updated analysis here.
Morrisons is being squeezed by the growth of the discounters and the cost cuts from ASDA. Leverage is already high and will continue to rise in FYE 26 before falling in FYE 27. Morrisons has sufficient cash to batten down the hatches. If further cash were needed, Morrisons has access to the Sale and Leaseback market to tide it over until the storm passes. The SSNs would be layered, but that is preferable to distress.
Investment Rationale:
- We have a 3% NAV long position in the £1.2bn SUNs; we did not participate in the tender offer as we are still comfortable with our position. We expect that CD&R would not allow £1.2bn of equity (including the £500m value of the MFG Stake) to be lost for the sake of £750m SUNs. Particularly as they do not need to inject cash. In the next 12 months, we see 5 points of upside in the SUNs (to trade at 10%) and 3 points of downside (to trade at 13%).
- We also have a 2.7% NAV long position in the 2027 SSNs. The SSNs are trading at par, and we will be seeking an exit.
- Morrisons is unlikely to call or refinance the SUNs as the new SSNs have a springing maturity if the SUNs are called early.
- We would not expect CDR to put more cash in (there is a £1.3bn preference issue in front of the equity), but access to the Sale and Lease back market means there are cheaper ways to raise cash, whilst waiting for the storm to pass.
- The 500bp spread between the SSNs and SUNs is excessive, and we expect this to narrow to 300bp (YTW 10%) in the next 12 months.
- Morrisons’ EV has come down due to the recent price drops at ASDA. Although LTV is now around 75%, the equity cushion is still significant.
- We do not see an all-out price war erupting, but we do see the current level of price support persisting for another 12 to 18 months.
Key Conclusions
- As we highlight in our Recent Trading section, Morrisons is still slowly losing ground to the discounters, whilst margins are under pressure from the price cuts at ASDA.
-Our DCF shows that the equity cushion for the bonds is now £1bn (ignoring the £500m value of the petrol forecourt stake). We expect recovery in FYE 27 and beyond, so with no substantial debt maturities (see Debt Profile section), CDR has time to wait this out. If further liquidity is needed, Morrisons could return to the S&L market.
-Our Model section shows that leverage will begin to fall in FYE2026, free cash will cover interest charges in 2026, rising to 1.3x in 2027. Whilst this is low, it is improving.
- Morrisons Q3 FYE25 LFL sales growth was less than food inflation, so volumes are still falling. Most of the £780m in cost cuts since 2023 have been absorbed by price support. The environment will improve, but not quickly.
- As our Risk and Value section points out, the CMA may allow one more merger, given the growth of the discounters. This may be the exit for Morrisons and ASDA.
The operational environment is tough, but manageable
- In Q3, Morrisons remained under pressure as price competition continues to hurt margins and volumes.
- However, the company has access to capital via the S&L market (at 6.5% or lower) and limited maturities before the 2027 SUNs maturity.
- In the quarter, sales rose 3.0% LFL, but with food inflation of 4.5%, volumes are clearly suffering. Management acknowledged this and said the trend will continue into Q4. Underlying EBITDA was flat at GBP 239m, but this is against >GBP60m of cost reductions, which were consumed by higher costs and price support.
- The cost-saving programme launched at the time of the buyout has already delivered GBP789m, with GBP200m to come in FYE 26. However, much of these additional savings will also go into supporting volumes and higher taxes. Next year, additional taxes will add GBP180m (annualised) to the cost base (around GBP70m will be reflected in the 2024/25 results). This should be ameliorated by £100m in cost cuts.
I look forward to discussing this with you all
Aengus
T: +44 203 744 7055