The Food and Drug sector has been by far the worst performing area of the UK stock market so far in 2014, plummeting by more than 42% over the year to date.
The problems facing UK grocers have been well documented, and Morrisons has often been treated as the least fashionable public company in what is, for now, the least fashionable industrial sector.
Yet, beneath all the negative sentiment, Morrisons (LSE: MRW) actually displays some promising investment characteristics. At least more so than Tesco (LSE: TSCO) – the market leader that has so often put it in the shade in the past.
Morrisons – Better Than The Rest?
While Tesco can’t seem to find an end to all the bad news and Sainsbury’s is eerily quiet (for now), Morrisons has taken the painful but necessary path of ditching all of its bad news in one fell swoop. It has faced up to the structural issues facing UK grocers, and has also specified how it aims to combat a perfect storm of threats to the industry.
Management intends to free up some £1bn of cash over the next three years via property sales and cost-cutting – a decisive strategy that should close the price gap with discounters, which have seen their market share surge in recent times. The freeing up of this cash has also allowed it to raise its dividend by 5%. Compare this with Tesco reducing its own by 75% over the same period.
On The Front Foot
Morrisons is beginning to see the benefits of these changes and its core business should improve thanks t0 revamped operating systems, while its current price cuts and promotions are the first of many over the next few years.
The company is belatedly expanding its convenience store footprint and online offering, suggesting that, while it has lost ground to rivals in these areas, there could also be easy gains going forward as it learns from the strategic execution of its peers. There is also a Morrisons card launch in the works – potentially a valuable asset in these days of Big Data collection and flagging customer loyalty.
Strategic Assets
Morrisons owns 90% of its stores. As mentioned above, it will partially fund its price cutting spree by selling some of these. Tesco, on the other hand only owns around half of its store portfolio, and so the sale of property is a much less viable strategy in funding its own price cuts.
Not only can Tesco not sell so many assets at a time when it desperately requires funds, it also has much higher lease commitments. While Morrisons’ lease obligations are £862m, Tesco needs to shell out a whopping £11.3bn in rent – some 46% of its adjustable debt.
Furthermore, Morrisons now has a stronger profit margin than Tesco and is cheaper on a debt to EBITDA basis.
Conclusion
Considering these factors, it is easy to conclude that Morrisons is the better-placed of the two retail giants. Tesco has much more to do and much more to lose than its oft-neglected peer. However, while Morrisons has a clear strategy and a bumper dividend, earnings visibility in the sector must improve before this share can be anything other than a speculative bet.