Morrisons - Revisiting Options - Model Update

All,

Please find our updated analysis on Morrison post its Q2 numbers here.

We have rotated our analyst coverage, with fresh eyes now looking at the Morrison capital structure. Although we have lowered our EBITDA forecasts for FY26 and FY27, and in turn lowered our DCF multiple, our overall conclusions remain the same. We expect a stabilisation of margins in the coming quarters, and with the potential for sale and leaseback and the sale of the MFG stake, asset coverage will underpin bond prices in the capital structure. 

Investment Rationale:

  • We are maintaining our 3.2% long position in Morrisons' Senior Unsecured Bonds. While the capital structure remains highly leveraged, these bonds continue to offer an attractive yield relative to their downside risk. We have to acknowledge that these bonds are highly illiquid and tightly held, with limited secondary market liquidity.

  • On our analysis, the Senior Unsecured Bonds remain covered. Assuming the retained Motor Fuel Group (MFG) stake is worth approximately £550m, there is meaningful asset coverage for the bonds. Excluding the MFG stake, our conservative valuation of the supermarket business at 5.5x EBITDA broadly covers the Senior Unsecured Bonds, while the MFG stake provides additional downside protection. We intend to undertake further work on the valuation of the MFG interest.

  • We see limited near-term upside for the bonds. With more than two years remaining to maturity, management's priority is likely to remain on improving operational performance rather than addressing the capital structure. As a result, we do not expect a refinancing or liability management exercise in the near term.

  • Equally, we believe the downside is limited. The Senior Unsecured Bonds benefit from meaningful asset coverage and sit ahead of the £1.3bn of preferred equity held by Goldman Sachs, Ares.

  • We have previously exited our position in the Senior Secured Notes. While we currently view those bonds as fairly valued, we may revisit the opportunity following further work on the credit. Net leverage, excluding the MFG stake, is approximately 4.4x, a level we believe is supportable based on both our discounted cash flow valuation and debt carrying capacity analysis. However, with the Senior Secured Notes yielding around 7% in euros and 9% in sterling, we believe they are trading close to fair value and offer less compelling upside than the Senior Unsecured Bonds.


Recent Trading:

  • Morrisons reported another resilient quarter, with like-for-like sales increasing 2.2% and underlying EBITDA rising 4.2% YoY to GBP172m, demonstrating continued stabilisation of the operating performance despite ongoing competitive pressure across the UK grocery market.

  • Trading momentum remains encouraging, although the business remains sub-scale relative to larger grocery peers and the benefits of operational improvement are partly offset by the company’s elevated leverage burden.

  • Management reaffirmed FY26 CapEx guidance of c.GBP330m and provided greater visibility on cash flow expectations by guiding to FY26 interest expense of approximately GBP275m, highlighting the ongoing importance of cash generation in managing the company’s leverage profile.

  • Operational execution remained a key positive, with cumulative cost savings increasing to GBP942m, continued progress on working capital initiatives and management indicating that the GBP1bn savings target should be exceeded. These initiatives are supporting cash generation, although the majority of the benefit is required to offset the company’s high interest burden and support gradual deleveraging.

  • The Q&A remained heavily focused on balance sheet strategy and cash generation, with investors probing refinancing options, the use of surplus liquidity, potential real estate monetisation and the strategic value of the company’s MFG stake. While management highlighted multiple sources of financial flexibility, investors remain focused on how Morrisons will address the 2028 maturity wall.

  • Management reiterated that there is no immediate refinancing requirement, supported by available liquidity and internally generated cash flow. However, investor attention remains firmly on the GBP750m 2028 maturity, where potential solutions could include MFG monetisation, property-backed financing or refinancing. Management continues to emphasise a preference for measured deleveraging while retaining strategic flexibility.


Options available: 

  • Although we do not envisage any immediate capital structure changes, we are beginning to focus our analysis on the potential options available to CD&R to address the Senior Unsecured Bond maturity. While the maturity remains more than two years away, we believe it is important to assess the range of balance sheet levers available, including further sale-and-leaseback transactions and the potential monetisation of Morrisons’ retained equity stake in MFG.

  • The MFG stake represents a meaningful source of potential liquidity, while Morrisons’ significant freehold property estate provides additional flexibility through asset-backed financing. However, both options need to be considered in the context of long-term deleveraging, as monetising these assets would reduce some of the remaining strategic flexibility within the capital structure.

  • As stated, there is currently no immediate refinancing pressure, and we expect management’s priority will remain on operational execution, improving cash generation and continuing to reduce leverage organically. However, with multiple balance sheet levers available, we believe Morrisons has sufficient flexibility to address the 2028 maturity while preserving value for bondholders.


Tomás

E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk

Tomás MannionMORRISONS