I admit it: I called it wrong, back in May, when I suggested that it might be time to average down on Wm. Morrison Supermarkets (LSE: MRW) (NASDAQOTH: MRWSY.US).
Since then, Morrisons’ share price has fallen by a further 18%, and is currently bumping along at a nine-year low of around 165p.
As a Morrisons shareholder myself, I’m feeling the pain, but I believe that although my timing was out, the value investment case for Morrisons remains intact.
Valuation
My first mistake was to fail to look closely enough at Morrisons’ valuation, relative to both its historic and forecast earnings:
| P/E ratio | Current value |
| P/E, using 5-year average adjusted earnings per share | 6.8 |
| 2-year average forecast P/E | 12.0 |
Source: Company reports, consensus forecasts
Morrisons’ forecast P/E of 12 is considerably lower than its historic P/E, indicating that the market expects Morrisons’ adjusted earnings to remain lower over the next couple of years.
However, it is worth noting that Morrisons’ two UK-listed peers, J Sainsbury and Tesco, both trade on forecast P/E ratios of just 10 –even lower than Morrisons. Based on this metric, Morrisons could have further to fall
What about the fundamentals?
One of the elements of the value case for Morrisons is its substantial freehold property portfolio, which was valued at £8.6bn at the end of last year.
Morrisons’ enterprise value (market capitalisation plus net debt) is just £6.7bn, which suggests the firm could be a bargain for an asset-stripping buyer.
However, it would be very hard for a buyer to realise this value if the majority of Morrisons’ stores weren’t going to continue to trade as supermarkets. Is Morrisons still a viable business?
Let’s take a look at some fundamentals:
| 5-year compound average growth rate | Morrisons |
| Sales | 2.8% |
| Adjusted earnings per share | -7.6% |
| Dividend | 9.7% |
| Book value per share | 201p |
| Tangible book value per share | 181p |
Source: Company reports
Sales growth has been broadly in-line with inflation over the last five years, while earnings per share rose gradually, until last year’s poor results dragged down earnings.
However, it’s Morrisons’ dividend that requires most comment: to everyone’s surprise, the firm has committed to a dividend payment of 13.65p this year, despite its collapsing profits. This equates to a prospective yield of 8.3%, at today’s share price.
Clearly this is unsustainably high — either Morrisons’ profits and share price must rise, or, most likely, the dividend will be cut. However, it’s worth noting that even if Morrisons’ dividend was halved, it would still provide an attractive 4.2% yield.
Buy Morrisons?
The supermarket is next due to update the markets when it publishes its first-half results on 11 September. I believe that the value investment case for Morrisons is now becoming quite compelling, but it remains a risky buy, in my view.