Morrisons - The Key Is Property - Model Update

All,

Please find our updated analysis, post-Q3 results, on Morrisons here.

We have not meaningfully changed our operating assumptions for Morrisons and have extended our projections by a further year. However, we have spent significant time assessing the potential for property monetisation to accelerate deleveraging. Recent management commentary has increased our confidence that sale-and-leaseback transactions could become a meaningful source of liquidity, with a c.£500m transaction reducing leverage by around 0.5x in our analysis. This provides an additional catalyst for the Senior Unsecured Bonds alongside the ongoing operational recovery.

Investment Rationale:

We are maintaining our 3.2% long position in Morrisons’ Senior Unsecured Bonds, initiated shortly after the deal failed when a bout of liquidity created an attractive entry point. The bonds continue to offer an attractive yield with strong downside protection, although they remain highly illiquid and tightly held. We entered this position in 2022 and are stuck with it, but not unhappy.

The Senior Unsecured Bonds have meaningful asset and business-value coverage. Our conservative 5.9x EBITDA valuation of the supermarket business broadly covers the bonds before assigning any value to the retained c.£550m MFG stake, providing additional asset backing.

Operational improvement remains the main fundamental catalyst. Management continues to focus on margin recovery, cost savings and cash generation, while property monetisation provides an additional route to deleveraging. Net leverage excluding MFG is approximately 4.7x, which is supported by our DCF and debt-capacity analysis.

The capital structure provides further protection, with the Senior Unsecured Bonds sitting ahead of c.£1.3bn of preferred equity held by Goldman Sachs and Ares.

We have previously exited our position in the Senior Secured Notes. We see a further 1–2pts of upside in these bonds, but given our existing exposure to the Unsecured bonds, we are not adding to our Morrisons position.

Recent Results:

Morrisons’ trading momentum strengthened in Q3, with LFL sales up 3.2%, the strongest quarter since Q2 FY25 and the 15th consecutive quarter of growth. Volumes grew ahead of the market and market share improved, with supermarkets, online, and Convenience all delivering positive LFL growth.

The improved pricing position is gaining traction, with c.570 products now benchmarked against the cheapest major retailers. Management said the investment is being funded through cost savings, supplier support and better control of waste, shrink and yield, with the objective of driving volumes and market share while maintaining profitability.

Underlying EBITDA increased 2% YoY to £272m in Q3 and 4% YTD. Management noted that inflation remains embedded in the cost base and therefore limits operational leverage. Despite increased investment in the proposition, Morrisons grew EBITDA and held margins as stronger sales and volumes came through.

Cash generation also improved materially, with Q3 operating cash flow of £104m, up £95m YoY, and FCF broadly breakeven at -£2m. The working-capital programme has now delivered £660m of cumulative savings, with the target increased to £750m, while FY26 capex guidance remains around £330m.

The balance sheet provides significant flexibility, with £3.1bn of total net debt, £400m+ of cash and £1bn of undrawn RCF capacity. Management said the 2027 debt stub is well covered by cash, although no decision has yet been taken on whether to use the cash to repay it. Property is expected to contribute to future deleveraging, with management indicating that execution will depend on finding the right partner, price and timing.

Opportunities to Delever:

Sale and Leaseback

Supermarket operators have an established track record of using their property estates to raise liquidity, with recent transactions involving Morrisons, Asda and Waitrose demonstrating continued institutional appetite for supermarket real estate. The long-term, relatively defensive nature of supermarket leases and the strategic importance of the stores support investor demand.

Against this backdrop, we see a c.£500m sale-and-leaseback as a credible source of additional liquidity for Morrisons without requiring a broader restructuring of the property estate.

The principal cost is the creation of a new long-term rental obligation. Assuming an initial yield of 7.5%, a £500m transaction would imply incremental rent of approximately £38m p.a., before subsequent inflation-linked increases. This compares with an immediate £500m cash inflow, which could be used to reduce debt or support liquidity.

In our analysis, this reduces leverage by approximately 0.5x, with only a modest impact on interest cover. The transaction would therefore be value accretive to all stakeholders, while providing a clear catalyst for the Senior Unsecured Bonds.

Sale of MFG Stake

We assign a low probability to a sale of Morrisons’ MFG stake, but include the proceeds for completeness. A recurring question has been whether Morrisons could realise the stake at book value or above. Our analysis shows that even at a 20% discount to book value, a disposal would provide meaningful deleveraging and improve interest cover. We therefore view the stake as a source of potential balance-sheet flexibility rather than relying on a sale in our base case.

Morrisons also benefits from its ongoing relationship with MFG, particularly through the supply of products to MFG’s convenience estate, meaning any disposal would not necessarily be straightforward. The stake was received as part of the consideration for the 2024 sale of Morrisons’ petrol forecourts to MFG and therefore represents a separate asset alongside the core supermarket business.

In a more stressed scenario, CD&R could potentially provide additional equity to Morrisons in exchange for some or all of the MFG stake, providing an alternative route to inject capital into the business without requiring an external sale.

Here to discuss this name with you,

Tomas

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