Morrisons – Green shoots.
All,
Please find our updated analysis here.
The FY 21/22 results from Morrisons in Q4 showed enough life for us to leave our thesis on the company unchanged. Morrisons is beginning to see stabilisation in its top line, and we expect volumes will recover in 2023. In the short term, however, we see LTM leverage rising significantly through January and we will wait to take any more of the name until those numbers have been reported. We appreciate the efforts to invest in price funded by sales and leasebacks. Selling freehold assets represents a transfer of risk to debtholders, but it is a necessary evil to maintain the top-line health of the business. In the long run, however, we see the retailer in an overall robust position and expect performance to stabilise over the coming year.
Positioning:
- Late last year, we took a 2% position in the SSNs and 1% in the SUNs. Our investment was a little early. Morrisons will suffer cost headwinds in Q122.23 but will reduce over the rest of the year. We will consider increasing our position after reviewing the January numbers, due in April. Morrisons is a low volatility, non-discretionary spending underlying business with a bad balance sheet.
- We aim to earn a front-loaded 12% and 17% YTM as the company stabilises in H2 of 2023, while only taking a limited risk-given-default. Should Morrisons have to restructure, we are confident about our position and expect any fight for value to break out beneath the bonds.
FY 2023 will improve as the year goes on:
- Q123 will be weak, but FY EBITDA will be higher than LTM.
- It’ll get worse before it gets better: Higher costs in the manufacturing side of Morrison's business are not being passed on fully to customers, which will crimp gross margins in H1. Price support will drop into H2 but is not going to cease. There are also some phasing issues around promotional support payments that will create a one-off cost in the first quarter.
- LTM Leverage will rise in Q1 by well over one turn, increased by a strong comp quarter dropping out and a very weak, COVID-impacted Q222 staying in the time frame. The LTM stats will normalise after Q223, so we will be looking to buy more in the summer.
Sale and Leaseback transactions provide liquidity for price support:
- Morrisons is planning to invest in price support, and the sale and leaseback transaction late last year will provide over £220m to fund it. Cost of living pressures continue in the UK, so this lease transaction will not be the final deal.
- The deal was at a discount to the cap rates for prime logistics space (>7% vs 4%), but it was cheap relative to senior debt at 13%.
- Selling assets to invest in price support cannot be repeated indefinitely, but price positioning is a key competitive tool for grocers and we are inclined to take it on the chin. Morrisons has over £7bn of mainly freehold assets, a considerably higher share than its competition.
I look forward to discussing this with you all.
Aengus
T: +44 203 744 7055