Morrisons – Fuelling The Future
All,
Please find our updated analysis here.
A sale of the forecourt business would be a significant deleveraging event for Morrisons. On next week's results call, investors will want to know more about the deal, but management may not be able to engage.
From our modelling, Morrison's operational results will have improved, with working capital flow helping further. Price support is still needed, meaning margins will stay lower for longer, albeit with some improvement. Spending cash to support market share is a price the grocer needs to pay. Our stance on supermarkets remains the same; discounters' market share ebbs and flows on consumer confidence, and soon they will ebb. The Competition Authority is not keen on allowing any mergers between the Big 4, and the Discounters are not about to launch a massive building plan.
Investment Rationale:
We continue to hold our 2% position in the SSNs and 1% in the SUNs. The positions are performing as expected (+8 and +5 points). Morrisons will suffer cost headwinds in Q122.23, but these will reduce over the rest of the year. 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 while only taking a limited risk of default. Should Morrisons have to restructure, we are confident about our position and expect any fight for value to break out beneath the bonds.
- A potential forecourt sale would prompt a significant rally, which could lead us to review our position. However, we are waiting for more details.
The sale of the forecourt business should be a positive catalyst for debtholders:
- In early September, CD&R acknowledged press reports that it was considering selling the Morrisons forecourt business to MFG, also owned by CD&R. An EV of £2.5bn was cited, with a £2bn equity value. The Morrisons forecourt is about the same size as the assets ASDA is acquiring from EG Group.
- The deal would reduce PF FYE23 leverage at Morrisons from 6.9x to 5.2x. There may be an arrangement for Morrisons to continue supplying the shops. We would also question what the impact on Morrisons convenience strategy was. A proportion of the convenience growth was to come from forecourt operations, but there will be some form of non-compete. With no major maturities imminent, there is no pressure to complete a deal. However, CD&R may want to get it done for their internal reasons.
- It is conceivable, but we think it unlikely that the sale of the forecourts business has been forced on CD&R as a way of quickly deleveraging the business; this would surprise us as there are no maturities at Morrisons until 2027.
- Supermarket fuel pricing has recently been subject to a CA probe and comments from UK Parliamentarians. The CA couldn't find collusion but noted that when the price leader (ASDA) raised its prices, so did all the other supermarkets. The CA could look for another bite, given MFG's market share. However, we would expect the deal to be approved.
- From the limited data provided the Morrisons forecourts are going at a lower price (£6.9m per forecourt), than the £7.4m being paid by ASDA. Some of the ASDA business is Motorway service stations which are likely to attract a higher price (regulated competition). We do not know the margins of the Morrisons business yet, so it is difficult to draw firm conclusions.
23Q3 will show continued improvement:
- We expect flat gross margins but higher gross profit as the top line grows. Price rises on certain products are still being balanced by continued price support elsewhere in the basket. Lower costs due to timing will help further boost EBITDA.
- Operational cash flow will rise on the back of higher gross profit and EBITDA with a further boost from working capital inflows.
- Leverage is coming down, but we still forecast it above 7x (excluding the preference shares) at FYE23. However, the trough in EBITDA is past, and we expect deleveraging to be quick over the next couple of years.
- Price support will still be necessary but will taper off.
I look forward to discussing this with you all soon,
Aengus
T: +44 203 744 7055