Should you buy more shares and average down, or should you sell?
That’s the dilemma facing many Wm. Morrison Supermarkets (LSE: MRW) (NASDAQOTH: MRWSY.US) shareholders — and it’s certainly a debate I’ve been having with regard to my own shareholding.
In this article, I’ve taken a look at three factors that I believe should provide support for Morrisons’ current valuation, meaning that any recovery in sales could trigger decent gains.
1. Asset value
There’s no doubt that Morrisons’ £9bn property portfolio is a key element of its current valuation, and this is highlighted by the fact that the firm’s share price is within a few pence of its net asset value — it’s theoretical liquidation value.
2. Replacement cost
Investment valuation often focuses on relative valuations such as the price-to-earnings (P/E) ratio, where ‘cheap’ and ‘expensive’ depend on market averages, which change over time.
An alternative approach to valuation is to think like a trade buyer, and look at the replacement cost of a firm — would it be cheaper to buy the existing business, or to build it yourself?
In addition to its £9bn property portfolio, Morrisons has a well-known national brand, which is strongly identified with good quality fresh produce and family values, and which generated sales of £17.7bn in 2013/14.
The current price tag for all of this is about £7.5bn, which is Morrisons’ enterprise value (market cap plus net debt). There’s no way that anyone could create a competing business for that amount of money, so Morrisons looks cheap as a potential takeover target.
3. Tax savings
Morrisons could also be an attractive takeover target for a different reason — tax. The supermarket could offer significant savings to a US firm wishing to cut its tax bill by moving its tax base to the UK, a manoeuvre known as tax inversion.
It may be politically unpopular, but the financial logic is clear: US companies usually pay corporate tax at 35%, whereas the equivalent rate in the UK is just 21%. As we saw with Pfizer’s failed takeover bid for AstraZeneca, tax inversion can be a big motivator in a deal, and Morrisons would be easily affordable for a number of potential US buyers.
Still risky
However, Morrisons remains risky: sales may continue to decline, the firm’s 6.5% dividend yield looks vulnerable to a cut, and it’s always risky to rely on takeover bids for your investment profits.