When I think of supermarket chain Morrisons (LSE: MRW) (NASDAQOTH: MRWSY.US), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.
1) Competition
Being a supermarket operator has always involved plying your trade in a fiercely competitive market place. In my area, for example, I could comfortably walk to a big-store branch of Morrisons, Tesco, Aldi, Lidl, Co-op or Asda. Such choice leads to an industry characterised by high volumes and low margins: supermarkets have to work hard to earn a little, and one slip in the big figures such as revenue or costs can lead to a big tumble in the small figures like cash flow and net profit.
Against that backdrop, there’s been a further shift in the trading environment: the customer shift to a preference for heavy discounting as exemplified by the likes of Aldi, Lidl and, to a certain extent, Asda, in the wake of the recent recession. It’s hard to disagree with Morrisons’ chairman when he says he thinks that shift is structural this time rather than cyclical as it has been after previous macro-economic low points.
The process seems part of a continuum: corner shops gave way to supermarkets, the discounters of yore, and the supermarkets now face the advance of modern discounting food retailers. We can look at parallels in other areas of retailing to see how things might pan out. For example: fashion clothing, which migrated from department stores through specialist fashion retailers to discount stores such as Primark; general merchandising took a similar path, which led to the demise of first-wave discounters such as Woolworth. On top of that, all retailing sectors face continued pressure from internet retailers such as Amazon.
The trading landscape could be changing forever for supermarkets like Morrisons, which could lead to ongoing pressure on cash flow and the dividend.
2) Late to the growth party
With the recent full-year results, Morrisons’ chairman was refreshingly candid. He reckons the rest of the market has been working hard to counter threats to the industry, with particular emphasis on loyalty programmes and personalised couponing. Morrison, however, has been unable to participate fully because of its outdated IT infrastructure and systems. That, combined with the fact that the firm does not have a meaningful presence in online retailing and convenience stores, led to the company announcing a recent 2.8% decline in like-for-like sales and a 13% decline in underlying pre-tax profit.
So, Morrisons now faces what it describes as a “significant and sustained” catch-up investment programme to redress its hitherto tardy embrace of the supermarket sector’s key growth areas.
Being behind the curve like that makes forward expansion plans feel like a bid for survival rather than some foresighted growth initiative. If Morrison goofs up on developing its online and convenience store presence, or on sorting out its IT, it’s conceivable that cash flow and profits could slip yet further, which could jeopardise the dividend-progression policy.
Despite such concerns, and in a display of confidence, Morrison hiked its dividend by 10% recently and that forward yield, running at about 6% for 2016, looks attractive.