Morrisons PLC Purchase Analysis - Essay Example

Morrisons plc Introduction: Morrisons purchased the Safeway chain of stores in 2004, after competition regulators blocked the other three supermarket chains – Tesco, Sainsbury and Asda from integrating Safeway, which was in the fourth position then (Flanagan, 2005). The following report will demonstrate that this purchase may have constituted a bad decision on the part of Morrisons Financial Management, since it has impacted adversely upon shareholder earnings. It may be argued that adequate thought and planning has not been given to the acquisition of the Safeway chain stores, especially during a period where intense competition and rising prices of doing business in grocery have squeezed profit margins available to retailers. Analysis: Morrisons has recently experienced losses as it has struggled to integrate the Safeway chain of stores into its own retail base, which has caused its annual profits to drop substantially. Its shares plunged 3% in 2005, to recover somewhat by the end of the year and close off at 183 p or a 2% plunge of 3.75 pence.(Flanagan, 2005). As opposed to the predictions of financial analysts of an income of around 225 million pounds, it only posted profits of around 134.2 million pounds before taxation, with an earnings per share of 3 pounds and 52 pence.(www.morrisons.co.uk, 2006/7). In 2006 however, the position has improved for the 52 weeks that ended January 29, 2006, as per the revised income statement that has recently been published by Morrisons.(www.morrisons.co.uk, 2007). While the losses before taxation were reported as 312.9 million pounds, the same figure shoots upward to 374.4 million pounds when taking into account the Safeway conversion costs. However, the adjusted income before taxation is 61.5 million pounds profit, with net profit after taxes being 45.9 million pounds. Operating revenues from the year 2001 are shown as follows: (source:www.uk.finance.yahoo.com) YEAR 2005 2004 2003 2002 2001 Net Operating Revenues 12,116.10 4,944.10 4,228.50 3,918.00 3,500.00 Net Profit 205.7 197.6 179.5 154 142 During the corresponding period, the share prices, the earnings per share have been as follows: YEAR 2005 2004 2003 2002 2001 Earnings per share 8.10 12.59 11.53 10.02 9.31 However, as pointed out above, the earnings per share of the Company have dropped to 3.52 pounds per share in 2006. The current share prices of Morrison stock is in the range of 250 to 260 pence and has been moving within this range to about 350 pence, which is an average of about 3 pounds per share. The price to earnings ratio is therefore 3 /3.5 = 0.87, which provides an indication that the stock may be overpriced as compared to the returns that are being generated from it. Earnings on stocks are not substantial either, and the high price to earnings ratio provides an indication that that investors may not be actively pursuing purchase of this stock because of their perception that it does not offer very high potential for gain and is in fact overpriced in the market in terms of its returns. As opposed to this, it may be noted from the Morrisons financial statement that the book value of the stocks is listed as an average of 5.7 pounds (www.morrisons.co.uk, 2006/7). Therefore, the book value of the stocks is more than double the market value of the share which is about 2.5 to 3.5 pounds. The Morrison Company stocks may therefore categorized as value stocks. Value assets are defined as those with a lower liquidating or intrinsic value as compared to their book value (O’Shaughnessy 1998:2) Value stocks are those with a higher book to market value and are thus riskier than growth stocks which have a high market value, although value stocks are expected to yield higher returns in the future. One advantage that Morrisons may still enjoy from the point of view of investment decisions made about its stock by future investors is the efficient Market hypothesis postulated by Fama (1955) In his hypothesis, he has categorized the efficient market as one where information on current securities are freely available to all participants and there is active competition between them, such that at any point of time the actual price of a stock will be a good reflection of its intrinsic value. On this basis therefore, most individuals who buy and sell stocks do so based upon the relative book value as compared to the market value of a share. Hence, buyers of Morrisons stocks are currently paying less to purchase the stock than what the stock is supposedly worth, i.e, 5.7 pounds according to its book value. This ought to foster a trend towards buying of Morrisons stock, due to the perception that this is a value stock that will outperform the market over a long period of time. However, in reality, the lower rate of return on Morrison stock in terms of Earnings per share may not very a very favorable aspect for Morrisons in the short term, despite the fact that the stock has a high book to market value and therefore would be considered a value stock. Lakonishok, Shleifer and Vishny (1994) have highlighted the fact that the pattern of investing as practiced by institutional investors tends to focus on the short term potential of the stocks through recent activity in the market rather than making prediction about potential long term price of the stocks. From this standpoint, the short tem potential of the stocks in the market do not demonstrate as much potential as other stocks, because the Morrisons Company is still struggling with the financial implications of the Safeway takeover. Although the stock prices have been showing marginal increases, there is a need for the Morrison stocks to perform much better in terms of Earnings Per share which can only be achieved through higher profits and returns to investors. This does not appear to be likely to be achieved, since the current interim financial report also shows that there are high amounts of interest that are being as interest on bank loans which have been taken by the Morrisons Company in order to achieve the Safeway takeover. However, Morrison stocks may be viewed as those that demonstrate a high value premium in terms of the long term potential. Studies have demonstrated that a short term growth strategy has outperformed the market (Levis and Liodakis, 2001) although others contend that such out performance is only the result of the higher risk factor and that growth stocks may actually outperform value based stocks in the long run (Beneda 2002). When the prior history of Morrisons is taken into account as demonstrated above in the table of Earnings per share, it must be noted that the Earnings per share have been much higher in earlier years, so that the stocks have shown a high market value to book ratio, as a result of which they would have been characterized as growth stocks and been sought after by investors in the anticipation of quick short term profits. The Safeway takeover may thus impacted adversely upon the position of Morrisons shares in the marketplace in the short term. A strong value premium was found in the U.K. by Dimson et al (2003). They pointed out that value stocks appear to enjoy a high premium in many markets in the world, similar to the United States. Using the radio of Book-value-to-equity and Market-Value-of-Equity (BE/ME) as the determining factor is arriving at value, the authors discovered there was a strong value premium that existed in the United Kingdom for the period from 1995-2001, with an especially strong value premium among small cap stocks. However, they also discovered that strategies implemented in order to capture value premium within the small cap segment is a costly exercise. This highlighted one aspect of the differences between the UK and US markets, since trading costs are an important element in the UK which significantly impact upon investor decisions. As a result, investors within the UK must factor in trading costs while assessing the prospective returns from stocks, especially when they are involved in a phase of active trading where short term returns are more important. While trading costs are also substantially higher where small cap stocks are concerned, as compared to the large cap stocks, the problem of trading costs is a much more severe one in the UK as compared to the United States and has a more substantial impact upon the decisions of investors, thereby correspondingly affecting value premiums as well. Hence, it appears possible that trading costs may place a damper on UK investors to invest in Morrison stocks in the current term, because in their assessment of the prospective return from stocks, the earnings per share does now allow for a very high profit margin as compared to the market price that must be paid to acquire the stocks. Analysts however had estimated that the Earnings per share of Morrisons stock could climb to 10.95 pounds in 2006 (www.uk.finance.yahoo.com). This has not materialized, just as the profits estimated for Morrisons in 2005-2006 also did not materialize, therefore indicating that the Safeway integration had been difficult for the Company to handle from a financial point of view, especially in view of the intense competition that exists in the grocery market with other supermarket chains such as Sainsbury and Asda. Morrisons has also recently challenged the Competition Commission’s focus on supermarket competition at the local level and has asked for steps to be taken to check Tesco’s national dominance (Clarke, 2007). They have stated that Tesco’s national dominance gives it an advantage in purchasing property and land, apart from providing an advantage in that they are able to buy packaged grocery products at lower prices than other retailers. A comparison of Morrison stocks with Sainsbury stocks reveals that the current share price of Sainsbury stock is about 5.5 pounds. According to its financial statements for 2006 and 2007, it also shows payment of interest charges to banks on finance charges, however these are nowhere in the magnitude of Morrisons and have reduced from 75 million pounds to 51 million pounds with the Company restructuring its debts.(www.j-sainsbury.co.uk) The basic earnings per share is 14.7 pounds, while the book value as of the end of 2006 was about 6 pounds, thereby demonstrating that Sainsbury stocks, unlike Morrisons are growth stocks. While the purchase value of the stock is 5.5 pounds, it is generating an income for investors of 14.7 pounds per share, which is definitely a batter rate of return than that offered by Morrison stocks, which are available in the market at a rate of about 3 pounds per share but are yielding an earnings per share of only 3.5 pounds. While the Price to Earnings ratio of Morrisons is 0.87, in the case of Sainsbury, it works out to 5.5/14.7 which is 0.37. This ratio is therefore not as high as that of Morrisons, indicating the stock is well priced in the market as compared to its earnings and therefore, there is likely to be more interest from investors in Sainsbury stock. Moreover, the five year summary of the Sainsbury financial statements shows that Earnings per share has dipped in recent preceding years – 2204,5 and 6, however the grocery store chain is showing a healthy trend currently because it has escalated its earnings per share by better management policies and has increased returns to investors. As a result, it is also in a position to pay higher dividends to its investors as compared to Morrisons. In the case of Asda, there is another significant threat that has been posed because this grocery store chain has recently been acquired by the Walmart chain of stores. In the year 1999, the Asda chain of stores reported net assets of U.S.$ 4.1 billion and when WalMart’s cash offer for the UK chain was announced in 1999, it represented a jump in Asda share prices to $15.1, which provided a premium of 46% to shareholders of Asda.(www.walmart.facts.com). Hence this grocery chain is now in an excellent position, just like Tesco that enjoys a market share of 30% in the U.K. market as opposed to much lower market shares for Morrisons and Sainsbury (Clarke, 2007) Conclusions: On the basis of the above, it appears clear that the move by Morrisons stores to integrate the Safeway chain may have been an ill timed move. It also appears likely that the retail store chain may have paid a higher price for the acquisition than may have been justified while it was carried out in 2005. As may be noted from the figures on operating expenses and profits provided earlier in this report, the Company had demonstrated a steady rise in profits despite the intense competition in the grocery sector, largely due to its efficient customer service and availability of items. The Company was therefore in the position of providing good returns to its shareholders, though food earnings per share and a low price to earnings ratio, which increased the value of the Morrisons stock. In view of the fact that the Tesco chain of stores is already a nationwide network and Walmart had acquired Asda, the market share grabbed by these Companies has been growing due to the economies of scale they enjoy in purchase of packaged grocery goods and acquisition of land and property (Clarke, 2007). However, despite the merger with Safeway, Morrisons has not been able to achieve similar economies of scale. This should have been anticipated by financial managers while considering the Safeway acquisition. During the past two years, not only has the earnings per share dropped for Morrison shareholders from a substantial 14 pounds into the region of 3 pounds per share, the same shares have also dropped in market value. As a result, Morrison stocks which were earlier growth stocks with good potential for short term growth and good trading prospects on the stock exchange has now deteriorated to the position where the price to earnings ratio has risen too high and it has become a value stock with higher book to earnings ratio. This will make investors shun the stock as overpriced, as a result of which the stocks have now become riskier to acquire in the short term and all potential for growth lies in the long term. But as demonstrated above, the greatest potential offered for stocks is often through their short term potential for trading, since this generates higher levels of activity and creates higher values for stockholders. It also appears that Morrisons stocks may take quite a while to recover their position in the market, since the company has indebted itself heavily and will need to pay off the loans or reduce its level of debt before it can show healthy profits and provide good dividends and returns to shareholders. In the context of the competitive environment that exists within the UK area for retail grocery, this merger could have been a particularly ill advised move. There is an increasing trend towards massification in the grocery chain business and corner shops have been disappearing rapidly in the U.K. During a time when Morrisons is not able to achieve the necessary economies of scale to compete effectively with grocery chains such as Tescos, it was all the more necessary for the financial management of Morrisons to exercise caution and restraint before embarking upon such an acquisition. Without the Safeway acquisition, Morrisons could possibly have continued its profitable trend, improving its services and customer service to survive effectively in the market, even if unable to compete with giants such as Tesco. However, this opportunity has now been forestalled by the Safeway acquisition and it may be a while before the Company is able to return value and good returns to its shareholders again. References: * Beneda, N. (2002). “Growth Stocks Outperform Value Stock Over the Long Term” Journal of Asset Management, 3(2), pp 112-23. * Clarke, Richard, 2007. “Morrisons calls on inquiry to challenge Tesco’s dominance.” Grocer, June 30, 230 (7786): 11(1). * Dimson, Elroy, Nagel, Stefan and Quigley, Garrett, 2003. “Capturing the value premium in the United Kingdom” Financial Analysts Journal , 59(6): 35 * Fama, Eugene F, 1995. “Random walks in stock market prices.” Financial Analysts Journal, Sept/Oct 1995. * Flanagan, Martin, 2005. “New Warning from Morrison.” The Scotsman, June 9, 2005. [online] Retrieved August 13, 2005 from: http://business.scotsman.com/topics.cfm?tid=711&id=631322005 * Lakonishok, Josef, Andrei Shleifer, and Robert W. Vishny. 1994. "Contrarian Investment, Extrapolation and Risk." Journal of Finance, 49(5), (December):1541-78. * Levis, M. and M. Liodakis. (2001). “Contrarian Strategies and Investor Expectations” Financial Analysts Journal,57(2), pp 43-56. * Morrisons Supermarkets. [online] Retrieved August 13, 2007 from: http://uk.finance.yahoo.com/q?s=MRW.L * O’Shaughnessey, J. (1998). “What works on Wall Street.” Revised edition. New York: McGraw Hill * “Sainsbury Financials” [Online] Retrieved August 13, 2007 from: http://www.j- sainsbury.co.uk/index.asp?pageid=206 Five year summary: http://www.j-sainsbury.co.uk/index.asp?pageid=208 * “Walmart announces recommended cash offer for Asda.” [online] Retrieved August 13, 2007 from: http://www.walmartfacts.com/articles/3525.aspx * WM Morrisons Supermarkets plc: Revised Income statement, 2007. [online] Retrieved August 13, 2007 from: http://www.morrisons.co.uk/Corporate/Resources/pdf/Accounting.pdf * WM Morrisons, Interim Report 2006/7. “Finnacial Summary.” [online] retrieved August 13, 2007 from: http://www.morrisons.co.uk/Corporate/Resources/pdf/Report.pdf Read More