Morrisons – Weathering - Positioning
All,
Please find our updated analysis here.
In a tough trading environment, Morrisons has managed to raise YoY EBITDA despite cost-cutting largely being consumed by headwinds from higher taxes, increased minimum wage and other government initiatives. Morrisons is adding revenue, but with inflation above 3%, volumes are still falling, overall Revenue was up 2.8% LFL. We see equity value under the debt stack, and with minimal maturities and a largely unencumbered store base, Morrisons can weather the current storms in the UK grocery industry.
Investment Rationale:
- We currently have positions in the 5.5% 2027 SSNs (2.7% of NAV) and the 6.75% 2029 SUNs (3.2% NAV). We are selling the 5.5% 2027’s at par. Since the purchase in November 2022 (@76%), the position has returned 46.6 points (including 23.625 points of coupon) equating to an annual return of 12.75%, which is 40 bp of the NAV. We will continue to hold the 6.75% 2029 SUNs, which returned 44 points (including 19.8 points of coupon) equating to an annual return of 12.5%, which is 33bp of the NAV. We expect that CD&R would not allow £1.2bn of equity (including the 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 (to trade at 13%) and 3 points of downside (to trade at 17%).
- 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 600bp spread between the SSNs and SUNs is excessive, and we expect this to narrow to 350bp (YTW 13%) in the next 12 months.
- From the DCF, LTV is now around 70%, and the equity cushion is still significant.
- We still 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. The launch of further discounts by Morrisons demonstrates that the pressure on margins is continuing.
- All grocers are pushing their suppliers to assist in defraying the cost of the price cuts. Eventually, there will be fatigue, and all of the grocers will need to inflate prices.
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.
Recent Trading
Q1 FYE26
- Morrisons managed to generate 2.8% LFL sales, but with food inflation running at over 3%, volumes are clearly still under pressure. The convenience business only saw 0.2% growth; falling tobacco sales (vaping and illegal sales) are hurting the top line here. New convenience store openings will rely heavily on franchises, which will reduce the necessary capital outlay for store openings. We are still sceptical about this business as we are not convinced the pie will get bigger.
- Underlying EBITDA (not IFRS 16 adjusted) is expected to rise in 2026. Our model has IFRS 16 Adjusted EBITDA rising 3% in FY 26.
- Morrisons continues to deliver cost savings, but these are currently being recycled into price cuts and cost headwinds. Morrisons intends to reveal a new cost-saving plan in Q2, but we expect that it will be largely to stand still. Since 2023, there have been £900m of savings, but at the same time, LTM Underlying EBITDA (the company’s favoured metric) has only risen 3% from £826m to £850m. - The cost-saving programme has already delivered GBP900m, with GBP100m 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 GBP200m (annualised) to the cost base (around GBP70m will be reflected in the 2024/25 results). This should be ameliorated by £100m in cost cuts.
- There are no near-term maturities to worry about and to capital via the S&L market (at 6.5% or lower) and limited maturities before the 2027 SUNs maturity.
- Morrisons remains under pressure as price competition continues to hurt margins and volumes.
I look forward to discussing this with you all
Regards
Aengus