Are Wm. Morrison Supermarkets plc And J Sainsbury plc At The Mercy Of Activist Investors?

Life is not easy for the big supermarkets. Consumers have been constrained for cash for years now. Not only have they less money to spend, they’ve also been skipping the “big four” in favour of cheaper fare from the likes of Aldi and Lidl. Falling spending and declining footfall are not a happy combination.

At the same time, many commodity costs have risen over the past few years, and price increases are hard to pass on to those cash-strapped consumers. Energy bills have remained stubbornly high, too.

At least supermarkets are among the few who can cheer the low wage growth we’ve seen recently, although you’ve got to feel for their employees.

Space evaders

A bigger existential threat is online shopping. You might expect sellers of carrots and cucumbers to be fairly immune to this, but big retailers like Tesco long ago diversified to sell everything from flatscreen TVs to school uniforms. That boosted sales in the good times, but it has also made them vulnerable to the same pressure from online as other bricks-and-mortar retailers like department stores.

Tesco has responded by pulling much of its electrical wares off the store floor to sell them online. But in turn that’s made the hypermarkets that were proliferating under Tesco’s ubiquitous banner a few years ago suddenly seem rather over-sized.

At the other end of the scale sits Morrisons (LSE: MRW) (NASDAQOTH: MRWSY.US). It doesn’t have the big space issue of Tesco – but it also doesn’t have the vast armada of local convenience stores rolled out by its rivals, and it has only just launched its online offering.

So while Tesco contemplates radical action like acquiring Mothercare to fill its voids, Morrisons would probably prefer the latter to go bust so it might pick up new sites cheap like it did after the demise of Blockbuster and HMV.

Make money from property

The irony is that while Morrisons has a property estate that’s fairly fit-for-purpose — compared to Tesco, which has those huge stores to deal with — its terrible trading recently has put it on the radar of activist investors who smell blood, and perhaps value.

You see, Morrisons owns around 90% of its stores, warehouses and offices (as well as its own abattoirs!) This property is worth £9-£10billion. Yet with a share price a little over 250p, Morrisons is valued at less than £6 billion.

You don’t need to be Warren Buffett to see an opportunity here. Theoretically Morrisons could be acquired, all the property sold, and investors could pocket £3 billion for their troubles.

In reality that won’t happen — for a start, who’d buy all those supermarkets, if not Morrisons? Plus while the supermarket is having a tough time —  sales plunged a breath taking 5.6% over Christmas — it’s still a profitable enterprise with millions of loyal customers.

Finally, Morrisons has debts as well as assets, although it also has cash and inventory that would go some way to covering its obligations.

Hedge funds hunting

But there’s a more realistic way to get at the value locked in Morrisons property portfolio. One reason it still owns so much property is that it hasn’t done what Tesco did years ago, which is to sell off lots of square footage to a third-party and then leaseback the space as a tenant.

This might seem rather circular, except that in theory Morrisons should be better at being a grocer than a landlord, and being a grocer should be more profitable, too. Therefore spinning off the property should – in theory – unlock value, which could either be returned to shareholders as cash or used for reinvestment.

There are rumours that Morrisons’ CEO will announce something along these lines in the next few months, but the idea has already attracted hedge funds keen to make sure he does. Activist investor Elliott Associates has taken a stake, as has Sandell Asset Management, the US fund agitating for a breakup of FirstGroup.

Taste the difference

What about Sainsbury’s (LSE: SBRY) (NASDAQOTH: JSAIY.US)? It’s arguably winning the war among the big four, cheering investors by posting a modest increase in like-for-like sales over Christmas.

Yet I don’t think Sainsbury can rest on its laurels. Despite its superior performance it trades on roughly the same P/E ratio (around 11) and dividend yield (very close to 5%) as Morrisons. I think this implies investors see the same pressures weighing on both companies.

Sainsbury has been active in managing its property portfolio. In November it took a £92 million write-down on the value of sites where it no longer plans to erect supermarkets, and it expects to open two new convenience stores a week in 2014. All in, it pegs the value of its property portfolio at £11.8bn, which is again way in excess of its £7bn market cap, although as with Morrisons there’ll be other assets and liabilities complicating the picture.

Sainsbury’s trading momentum and the easier pickings at Morrisons may keep activists away for now, but I still think there’s value hidden away in its bricks and mortar. Perhaps more likely given the strength of its business in fact is an all-out acquisition if a predator smells a bargain.

Dividends today, gains tomorrow

In 2007 Sainsbury’s share price approached £6 on a bid from Qatar Holding. Qatar remains the largest shareholder with a 26% stake, and with the share price languishing at £3.67 I could easily see Qatar trying again.

Smaller fry like us might be tempted simply to buy a basket of these cheap supermarkets. After all, you’re getting a dividend yield of around 5%, so you’re effectively being paid to wait for activists to successfully shake things up and unlock some capital gains, too.