the sell-side report for wm morrison supermarkets plc

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SSUUBBMMIITT VVIIAA MMOOOODDLLEE

COURSE NAME Financial Analysis and Equity Valuation

GROUP NUMBER Group 1

STUDENT ID NUMBERS

Dinu Olariu 2 1 6 1 2 9 0

Olga Katsarou 2 1 5 5 4 1 2

Cheng Yang 2 1 1 1 7 6 7

Inna Sokolova 2 1 2 0 2 1 1

DATE SUBMITTED: 2 3 0 3 1 5

WORD COUNT*: 2 5 8 6

*excluding bibliography, references and appendices

Table of contents

1. Executive summary……………………………………………………………………………….3

2. Industry overview, company background and business analysis………....………………………4

3. Performance analysis……………………………………………………………………………...8

4. Forecasting……………………………………………………………………………………….13

5. Valuation…………………………………………………………………………………………16

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3

WM Morrison plc. (MRW LN) Consumer & Retail

Food & Staples retailing

Equity - United Kingdom

FRIDAY, 13 MARCH, 2015 Intrinsic Price1 (GBP) 158

Share price2 (GBP) 204

Overvalued RECOMMENDATION

SELL

Potential return3 -22,50%

One-year forward target price

(GBP) 168

1. Executive summary

David Potts is the new CEO of Morrisons starting Monday, 16 March 2015. He has

previously spent 40 years at Tesco and was a member in the Executive Board for 14 years.

We expect no immediate changes in the company’s strategy. The Chairman backs the

current strategy of prioritising capital discipline, improving customer offer and developing

the online model, but he requested a better implementer.

The company announced declined performance in the last financial year, due to fierce

competition and a shift in consumers’ buying behaviour.

The firm is expected to maintain its dividend policy of at least 5p / share in 2015/2016, but

the pay-out policy is uncertain afterwards.

Over the last year, share price reached the highest value (214.90p) in March, 2014 and the

lowest point (151.70p) in October 2014, amounting for a decrease of 30% over 8 months.

The price recovered afterwards by approximately 34% and reached 204p on March 13.

Source: Yahoo Finance

1 Intrinsic price as of 13 March 2015. The price was determined using price multiples and the residual income model. 2 The share price as of 13 March 2015. 3 Potential return equals percentage difference between the intrinsic price and share price.


4

Hypermarket

s and

superstores

42%

Small

supermarket

s

20%

Convenience

stores

22%

Discounters

6%

Online

5%

Other

retailers

5%

Grocery sales channels, 2014

Source: IGD UK Grocery: Market and channel forecasts 2014-2019

2%

5%

14%

17%

Supermarkets Convenience Discounters Online

UK Grocery Channels: Annual growth, 2014-19e

Source: IGD UK Grocery: Market and channel forecasts 2014-2019

Exhibit 2.3

2. Company background, business strategy and position

Industry Overview

The UK grocery market has been growing constantly over the last 10 years. However, after the

financial crisis, the growth rate has decreased slightly, amounting for 2.8% in 2014.

Exhibit 2.1

Exhibit 2.2

Although hypermarkets and

superstores make up the largest

share in the UK grocery market,

online channels (17%),

discounters (14%) and

convenience stores (5%) are

estimated to register the highest

growth rate from 2014 onwards.


5

Tesco

26%

Sainsbury's

15%

Asda

14%Morrisons

11%

Co-op

5%

Waitrose

5%

M&S

3%

Aldi

4%

Lidl

3%

Iceland

2%

Farm Foods

1%Others

11%

The allocation of grocery market shares,

2014

Source: Morgan Stanley research

Exhibit 2.4

+32%

+20%

+3%

+1%

+1%

0%

- 2%

- 4%

- 4%

Aldi

Lidl

Waitrose

Sainsbury's

Asda

Iceland

Co-op

Morrisons

Tesco

Sales growth/decline over 2014

Source: Morgan Stanley research

Although the

leading chains in the UK

grocery market are

Morrisons, Tesco,

Sainsbury’s and Asda,

their revenues stagnated

or declined significantly

during 2014, while

discounters’ sales (Lidl

and Aldi) increased by

more than 20%.

Exhibit 2.5

Company background

WM Morrisons Supermarkets plc (Morrisons) was originally founded in 1899 as stall in

Bradford Market and is now considered the UK’s fourth largest supermarket group. Currently

Morrisons retails groceries through 605 stores across the UK, out of which 102 are convenience

stores. Following main market trends, Morrisons made their first home delivery via their online

service in January, 2014.


6

Structure, Business strategy and Value drivers

Regarding financial reporting, Morrisons has a very simple group structure, operating only a

single retail business and providing no divisional disclosures. At the same time, Morrisons has a

vertically integrated supply chain business model. The value is created by producing their own fresh

food and buying stock from other suppliers and further reselling them to final customers. Their

business strategy is based on price neutralisation and products differentiation. As for their

development strategy, the group is oriented towards addressing customer shopping preferences by

lowering prices on own-manufactured products, accelerating online shopping growth and new store

openings.

Table 2.1: SWOT-analysis

SWOT Analysis

Strengths 1. Offering fresh and quality food at competitive prices

2. Differentiating through Market Street which provides a large range of high-

quality food

3. Reputation of selling freshly-made food through own-operated facilities

4. A well-integrated supply chain

Weaknesses 1. Lack of development of online distribution network

2. Inefficient use of check-out machines

3. Most stores located in remote areas

Opportunities 1. International expansion

2. Rising awareness of organic products

3. Development of the online shopping platform

4. Increasing demand for brand-named products

Threats 1. Growth of discount supermarkets

2. Inability to keep up-to-date with market trends Source: Group’s analysis

Risks

Competitor proposition

The grocery market is facing fierce competition in the UK. Even though Morrisons is one of

the big four supermarket brands, its sales decreased while Aldi and Lidl increased significantly in

2014.

Growing online channel

Currently the online selling channel has the highest growth rate. Although this system is

underdeveloped in Morrisons, the company could increase their market share provided that they

further enhance their online platform in the near future. However, they are still far behind their

competitors and might incur difficulties in attracting customers loyal to other companies.


7

Competitors’ strategies

Some peers of Morrisons at European level are Tesco, Sainsbury’s, Carrefour, Metro and

M&S. Core future movements of these companies are listed as following:

Tesco: Focus on development of multichannel, personalisation and customisation as well as

opening more convenient stores and ensuring large stores to be more attractive.

Sainsbury’s: Increasing the supermarket’s opening hours.

Carrefour: Opening more convenience stores that are nearer their customers.

Metro: Improving the delivery service and expand their franchise.

M&S: Keep developing ‘Plan A’ which is an environmental and ethical-oriented programme.


8

3. Performance analysis

This section comprises a brief ratio analysis of the company, by emphasizing the findings of

various profitability and liquidity ratios, along with a common size analysis of income statement

and balance sheet.

Table 3.1: Common size analysis of the income statement

Vertical analysis

Item / Financial Year

2010 – 2011 2011 - 2012 2012 - 2013 2013 - 2014 2014 - 2015

Revenue 16479 100,0% 17663 100,0% 18116 100,0% 17680 100,0% 16816 100,0%

Cost of sales -15331 93,0% -16446 93,1% -16910 93,3% -16606 93,9% -16055 95,5%

Gross profit 1148 7,0% 1217 6,9% 1206 6,7% 1074 6,1% 761 4,5%

Other operating

income 80 0,5% 86 0,5% 80 0,4% 81 0,5% 78 0,5%

Administrative

expenses -324 2,0% -330 1,9% -337 1,9% -1250 7,1% -1670 9,9%

Operating

profit/loss 904 5,5% 973 5,5% 949 5,2% -95 -0,5% -696 -4,1%

Finance costs -43 0,3% -47 0,3% -75 0,4% -87 0,5% -105 0,6%

Finance income 13 0,1% 21 0,1% 5 0,0% 5 0,0% 7 0,0%

Share of profit of

joint venture 0 0,0% 0 0,0% 0 0,0% 1 0,0% 2 0,0%

Profit/loss

before taxation 874 5,3% 947 5,4% 879 4,9% -176 -1,0% -792 -4,7%

Taxation -242 1,5% -257 1,5% -232 1,3% -62 0,4% 31 -0,2%

Net Profit/Loss 632 3,8% 690 3,9% 647 3,6% -238 -1,3% -761 -4,5%

Horizontal analysis

Item / Financial

Year 2010 - 2011 2011 - 2012 2012 - 2013 2013 - 2014 2014 - 2015

Revenue 16479 100,0% 17663 7,2% 18116 9,9% 17680 7,3% 16816 2,0%

Cost of sales -15331 100,0% -16446 7,3% -16910 10,3% -16606 8,3% -16055 4,7%

Gross profit 1148 100,0% 1217 6,0% 1206 5,1% 1074 -6,4% 761 -33,7%

Other operating

income 80 100,0% 86 7,5% 80 0,0% 81 1,3% 78 -2,5%

Administrative

expenses -324 100,0% -330 1,9% -337 4,0% -1250 285,8% -1670 415,4%

Operating

profit/loss 904 100,0% 973 7,6% 949 5,0% -95 -110,5% -696 -177,0%

Finance costs -43 100,0% -47 9,3% -75 74,4% -87 102,3% -105 144,2%

Finance income 13 100,0% 21 61,5% 5 -61,5% 5 -61,5% 7 -46,2%

Share of profit of

joint venture 0 100,0% 0 0 1 2

Profit/loss

before taxation 874 100,0% 947 8,4% 879 0,6% -176 -120,1% -792 -190,6%

Taxation -242 100,0% -257 6,2% -232 -4,1% -62 -74,4% 31 -112,8%

Net Profit/Loss 632 100,0% 690 9,2% 647 2,4% -238 -137,7% -761 -220,4%


9

Table 3.2: Operating performance analysis – Historical perspective

Item / Financial Year 2010-2011 2011-2012 2012-2013 2013-2014 2014-2015

Gross profit margin 6,97% 6,89% 6,66% 6,07% 4,53%

Net profit margin 3,84% 3,91% 3,57% -1,35% -4,53%

EBITDA margin 7,43% 7,44% 7,27% 9,89% 5,09%

Personnel expense 11,04% 10,71% 10,73% 11,12% N/A

SG & A cost ratio 1,96% 1,86% 1,86% 7,12% 9,93%

Table 3.3: Operating performance analysis - Comparison with peers

Item in 2014-2015 /

Company

WM

Morrison Tesco Sainsbury

Marks &

Spencer Metro Carrefour

Peers

average

Gross profit margin 4,53% 6,31% 5,79% 37,54% 20,97% 19,48% 15,77%

Net profit margin -4,53% 1,53% 2,99% 5,09% 0,00% 0,02% 0,85%

EBITDA margin 5,09% 6,17% 6,12% 12,09% 4,04% 5,01% 6,42%

Personnel expense N/A 10,54% 9,70% 13,69% 11,41% 10,33% 11,13%

SG & A cost ratio 9,93% 2,61% 2,25% 31,27% 21,13% 16,47% 13,94%

Table 3.4: Performance analysis - Historical perspective


Return on Equity after tax 11,66% 12,78% 12,37% -5,07% -21,17%

Return on Equity before tax 16,13% 17,55% 16,81% -3,75% -22,04%

Return on Assets after tax 6,53% 6,60% 5,49% -2,97% -9,33%

Return on Assets before tax 9,17% 9,21% 7,69% -2,40% -9,67%

Net profit margin after tax 3,84% 3,91% 3,57% -1,35% -4,53%

Net profit margin before tax 5,30% 5,36% 4,85% -1,00% -4,71%

Earnings per share (pence) 23,43 26,03 26,57 -10,23 -32,63

Return on total invested capital after tax 169,44% 191,67% 189,18% -65,93% -210,80%

Return on total invested capital before tax 234,32% 263,06% 257,02% -48,75% -219,39%

Table 3.5: Performance analysis - Comparison with peers

Item in 2014-2015 / Company WM


Marks

&

Spencer

Metro Carrefour Peers

average

Return on Equity after tax -21,17% 6,62% 11,92% 19,39% 2,67% 14,99% 5,74%

Return on Equity before tax -22,04% 15,34% 14,95% 21,44% 14,92% 20,04% 10,78%

Return on Assets after tax -9,33% 1,05% 3,55% 5,11% -1,25% 1,84% 0,16%

Return on Assets before tax -9,67% 3,61% 4,65% 5,81% 0,94% 2,84% 1,36%

Net profit margin after tax -4,53% 1,53% 2,99% 5,09% 0,20% 1,70% 1,16%

Net profit margin before tax -4,71% 3,55% 3,75% 5,63% 1,12% 2,27% 1,94%

Earnings per share (pence) -32,63 12,06 36,90 32,20 31,95 154,54 39,17

Return on total invested capital after

tax -210,80% 17,76% 43,77% 68,73% 3,95% 71,18% -0,90%

Return on total invested capital before

tax -219,39% 41,19% 54,89% 76,01% 22,03% 95,19% 11,65%


10

The vertical and horizontal analysis of income statement reflect a declining performance in

the last 2 financial years. Specifically, the company’s revenues decreased significantly due to lower

store turnover - caused by the challenging trading environment - and fall in oil price. Although the

company registered a declined, but positive underlying profit (£345m) in the last financial year,

high expenses with property impairment and onerous lease provisions caused a major operating loss

of £696m. Another item causing significant growth in administrative expenses in 2014-2015 was

the firm’s investment in customer proposition (issuance of Match & More cards and various price

cuts). However, last year the company adopted and is currently following a 5-year plan aimed at

increasing cost savings, improving working capital and lowering capital expenditure, which could

diminish these administrative overheads in the future.

The evolution of the operating performance and profitability ratios confirm the company’s

above-mentioned weakened results. Over the last 5 years, all indicators decreased (gross profit

margin, net profit margin, EBITDA margin, ROA, ROE, return on capital invested) and earnings

per share were even negative for the last 2 years, despite the raise in dividends granted to

shareholders. Moreover, last financial year all profitability and performance indicators of Morrisons

were below the peers’ average and most of them were even the lowest ones among the 6 retailers

group. Interestingly however, the firm’s gross profit margin of 4.53% was close to those of its direct

competitors (Tesco and Sainsbury’s), indicating that there is potential for the company to improve

these figures and even overtake its competitors in the future.

Table 3.6: Common size analysis of the simplified Balance sheet

Vertical analysis

2010-2011 2011-2012 2012-2013 2013-2014 2014-2015

Non-current assets 8011 87,6% 8537 86,6% 9185 87,3% 9299 86,7% 7943 86,6%

Current assets 1138 12,4% 1322 13,4% 1342 12,7% 1430 13,3% 1144 12,5%

Total assets 9149 100,0% 9859 100,0% 10527 100,0% 10729 100,0% 9171 100,0%

Current liabilities -2086 55,9% -2303 51,6% -2334 44,1% -2873 47,6% -2273 40,8%

Non-current liabilities -1643 44,1% -2159 48,4% -2963 55,9% -3164 52,4% -3304 59,2%

Total liabilities -3729 100,0% -4462 100,0% -5297 100,0% -6037 100,0% -5577 100,0%

Net assets 5420 5397 5230 4692 3594

Total equity

attributable to the

owners 5420 100,0% 5397 100,0% 5230 100,0% 4692 100,0% 3594 100,0%

Horizontal analysis

Non-current assets 8011 100,0% 8537 6,6% 9185 14,7% 9299 16,1% 7943 -0,8%

Current assets 1138 100,0% 1322 16,2% 1342 17,9% 1430 25,7% 1144 0,5%

Total assets 9149 100,00% 9859 7,76% 10527 15,06% 10729 17,27% 9171 0,24%

Current liabilities -2086 100,0% -2303 10,4% -2334 11,9% -2873 37,7% -2273 9,0%

Non-current liabilities -1643 100,0% -2159 31,4% -2963 80,3% -3164 92,6% -3304 101,1%


11

Total liabilities -3729 100,0% -4462 19,7% -5297 42,0% -6037 61,9% -5577 49,6%

Net assets 5420 100,0% 5397 -0,4% 5230 -3,5% 4692 -13,4% 3594 -33,7%

Total equity

attributable to the

owners 5420 100,0% 5397 -0,4% 5230 -3,5% 4692 -13,4% 3594 -33,7%

Table 3.7: Liquidity analysis – Historical perspective


Quick ratio 0,24 0,24 0,24 0,20 0,25

Current ratio 0,55 0,57 0,57 0,50 0,50

Cash ratio 0,11 0,11 0,12 0,09 0,11

Cash / Total assets 0,03 0,02 0,03 0,02 0,03

Table 3.8: Liquidity analysis – Comparison with peers

Item in 2014-2015 /

Company

WM


Marks &

Spencer Metro Carrefour

Peers

average

Quick ratio 0,25 0,51 0,49 0,22 0,40 0,56 0,41

Current ratio 0,50 0,73 0,64 0,58 0,77 0,84 0,68

Cash ratio 0,11 0,41 0,48 0,16 0,37 0,48 0,34

Cash / Total assets 0,03 0,18 0,19 0,05 0,21 0,23 0,15

Table 3.9: Activity ratios - Historical perspective


Inventory turnover 24,03 21,67 21,65 19,49 24,40

Average no. of days inventory in stock 15 17 17 19 15

Receivable turnover 61,49 55,20 62,25 55,95 53,22

No. days receivable outstanding 6 7 6 7 7

Total assets turnover 1,80 1,79 1,72 1,65 1,83

Non-current assets turnover 2,06 2,07 1,97 1,90 2,12

Table 3.10: Activity ratios – Comparison with peers



Marks & Spencer


average

Inventory turnover 24,40 16,65 22,45 7,62 8,82 10,64 15,10

Average no of days inventory in stock 15 22 16 48 41 34 29

Receivable turnover 53,22 29,02 191,60 81,31 118,45 34,25 84,64

No. days receivable outstanding 7 13 2 4 3 11 7

Total assets turnover 1,83 1,27 1,45 1,3 2,37 1,74 1,66

Non-current assets turnover 2,12 1,84 1,96 1,58 4,26 2,98 2,46


12

Table 3.11: Debt & long term solvency ratios - Historical perspective


Liability-to-equity-ratio 0,69 0,83 1,01 1,29 1,55

Debt-to-equity ratio 0,55 0,67 0,86 1,01 1,32

Debt-to-capital ratio 0,35 0,40 0,46 0,50 0,57

Total debt / Total assets 0,41 0,45 0,50 0,56 0,61

Total equity / Total assets 0,59 0,55 0,50 0,44 0,39

Table 3.12: Debt & long term solvency ratios – Comparison with peers



Marks & Spencer


average

Liability-to-equity-ratio 1,55 2,41 1,75 1,92 4,60 4,07 2,72

Debt-to-equity ratio 1,32 0,76 0,46 0,78 1,41 1,65 1,06

Debt-to-capital ratio 0,57 0,43 0,32 0,44 0,59 0,62 0,50

Total debt / Total assets 0,61 0,71 0,64 0,66 0,82 0,80 0,71

Total equity / Total assets 0,39 0,29 0,36 0,34 0,18 0,20 0,29

A brief balance sheet analysis reveals that over the last 5 years the current/non-current assets

ratio remained relatively stable, with no significant changes. Although by 2015 the intangible assets’

value raised with almost 200% since 2010-2011, the value of total assets remained relatively similar

due to the decrease in market value of fixed assets. However, a structural shift regarding company’s

debt policy can be observed in this period. Specifically, Morrisons contracted more long-term debt

since 2010 (increase of 138.4%), while the current debt has grown at a much lower rate (only 9%).

This trend was maintained last financial year, when the company issued a new 15-year £300m bond

and replaced its £1.2bn revolving credit facility with a 5-year £1.35bn facility. Still, although we

have witnessed constant increase in liability-to-equity ratio, this indicator was lowest against the

company’s peers in 2014-2015. Finally, the shareholders’ equity reduced overall relatively to 2010-

2011 mainly due to the significant fall in profit and, implicitly, retained earnings.

As far as the credit risk analysis is concerned, Morrisons had the lowest current ratio among

all peers in 2014-2015, which underlies both positive and negative aspects. The low quick ratio and

activity ratios show the firm manages its inventories better than its peers, mainly because of their

vertically integrated business model (based on owing most of their production facilities) and offer

of quality fresh food products. Nevertheless, taking into consideration the low cash ratio, we

assume that the company has some difficulties in terms of cashing in their revenues.


13

4. Forecasting

The key value drivers employed for forecasting are earnings, dividends and book value, as

one of the valuation models used in the next section is the residual income model. However, the

starting point of our forecast is the sales growth rate, because this is the main target indicator of

Morrisons’ business model. Morrisons’ sales forecast is derived from the company’s current market

position and estimated growth rate of grocery sector, which is justified by the high level of

dependency of market participants on the current industry trends (customer preferences of

shopping). The time period of our forecast includes 5 financial years, as after this period it is

difficult to predict industry trends and changes in customer behaviour.

Table 4.1 Forecasted income statement indicators, in £ millions

Item/Year 2015-2016 2016-2017 2017-2018 2018-2019 2019-2020

Revenue 15975 15576 15623 15669 15716

Cost of sales 15017 14641 14685 14729 14773

Gross profit 959 935 937 940 943

Other operating

income 78 78 78 78 78

Administrative

expenses 1587 1507 1250 625 625

Operating

profit/loss -550 -495 -235 393 396

Finance costs 105 105 105 105 105

Finance income 7 7 7 7 7

Profit/loss before

taxation -648 -593 -333 295 298

Taxation

59 60

Net Profit/Loss -648 -593 -333 236 238

Source: the calculations are based on the assumptions explained below.

Table 4.2 Forecasted value drivers for residual income model, in £ mln

Item/Year 2014-2015 2015-2016 2016-2017 2017-2018 2018-2019 2019-2020

Earnings -761 -648 -593 -333 295 298

Dividends 116.76 116.76 116.76 116.76 116.76

Book value 3594 2829 2120 1670 1849 2030

ROCE -21.17% -22.90% -27.96% -19.91% 15.96% 14.68%

Source: the calculations are based on the assumptions explained below.


14

Market analysis

According to the analysis of

the IGD4, the UK grocery market

sales will increase by 16.3% over

the next 5 years. Assuming a

consistent rate over these 5 years,

the yearly growth equals to 3.07%.

Importantly, the greatest growth

will be contributed by online sales,

discounters and convenience stores,

which will seriously affect Morrisons’ revenues. This is evidenced by the fact that underdeveloped

online shopping and high customers demand for discounters have already led to a decrease in

Morrisons’ market share by 1% since February 2014. We estimate further decline by approximately

1% during 2015-2016 year.

As most of Morrisons’ revenues come from grocery operations (revenues from gasoline

stations are relatively low), our forecast is primarily based on grocery market. Meanwhile, oil prices

are currently decreasing, which affects negatively Morrisons’ comprehensive income.

Business strategy analysis

The current business strategy is focused on customer expectations and needs. The new CEO,

David Potts, has announced that during his first weeks he is going to ask for feedback from

customers and employees regarding possible company improvements. This strategy is fairly

promising and represents company’s willingness to address customers’ preferences. However, the

implementation of substantial changes will not be effective right away. In fact, it will take some

time before the company will be in line with market growth. Therefore, we assume a continuing

decrease in sales at the last year’s rate of 5% during 2015-2016 and a decrease of 2.5% in 2016-

2017, as by this time the company is expected to start carrying out customer-oriented changes (the

development of an IT platform and online model, opening of new convenience stores - features

included in 2015-2016 strategic plan). The decrease in total sales during the first two forecasting

periods can also be explained by lower prices. This is due to the ongoing cost savings programme,

4 The Institute of Grocery Distribution, “The next five years: how the UK grocery market will evolve”

http://www.igd.com/our-expertise/Retail/retail-outlook/21115/The-next-five-years-How-the-UK-grocery-market-will-

evolve/

21,4%

6,2% 4,4%

68,0%

24,1%

10,5% 8,3%

57,0%

Convenience Discounters Online Superstores

and

hypermarkets

Sales channels proportions of grocery

market, 2014-2019

2014 2019

Source: IGD forecast

http://www.igd.com/our-expertise/Retail/retail-outlook/21115/The-next-five-years-How-the-UK-grocery-market-will-evolve/

http://www.igd.com/our-expertise/Retail/retail-outlook/21115/The-next-five-years-How-the-UK-grocery-market-will-evolve/


15

which has already lowered prices for own-brand products by 17%. From 2017-2018, we predict

sales growth in line with the market at a rate of 0.3%5.

The company does not have any stable payout ratio, and future dividend policy mostly

depends on the Board and the new CEO’s decisions. We predict Morrisons will not disregard

paying dividends completely as it would be inconsistent with the company’s past policy (the

company promised 2015-2016 DPS will not be less than 5p). Therefore, we assume DPS of 5p

during next 5 years as the financial situation will remain quite difficult.

Accounting and financial analysis

We assume finance costs relatively stable as most of long-term debt has fixed interest rates.

Administrative expenses are expected to decrease by 5% annually and afterwards to return

to the level before the implementation of the cost saving programme.

Other operating and finance income is assumed to be constant as there are no significant

prerequisites for their change.

The corporate tax rate which Morrisons uses starting April 2015 equals 20%.

As it was derived from financial analysis, ROCE has been decreasing recently because of

lower profit and as reflected in our forecast, current prospects are rather negative.

5 0.3% is calculated by multiplying market growth of 3% by WM Morrison market share of 10%.


16

5. Valuation

For the valuation of Morrisons we used two different methods, specifically Price Multiples

and Residual Income Model.

Multiples

Multiples, and especially P/E, are used by the vast majority of analysts. This method relies on

the assumption that companies of similar size, performance and object of activity should have a

similar share price. In our evaluation, we use a set of different multiples in order to estimate

Morrisons' intrinsic price i.e. Normalised P/E, P/B, EV/Sales and EV/EBITDA.

Unfortunately, Morrisons had losses for two consecutive years so we used normalized

income6 for our analysis. Furthermore, in the retail industry, sales are the key performance indicator

which determines the profitability and future growth of the company, which led us to also include

EV/Sales multiple. However, the ability to minimise costs is considered to be of equal importance,

so EBITDA is a good proxy for the profitability of the company, as it is not influenced by

differentiations in capital structure, depreciation methods and other accounting techniques. Finally,

the selection of these multiples was underpinned by the fact that the majority of investors used the

aforementioned multiples when they evaluated Morrisons’ peers. Especially P/B can be used as a

measure of the consensus for the company’s growth opportunities.

The peers were selected from the UK and European food retail sector. However a number of

potential peers were excluded from our analysis either because they were not publicly listed

(Waitrose, Iceland, Co-op), they were not directly comparable (Asda as subsidiary of Walmart

which used US GAAP), or they were heavy discounters (Lidl and Aldi).

Moreover, in order to collect the data we used peers’ financial reports. In the cases that annual

reports were not published in the last quarter, we combined data from the last two semi-annual

results (M&S, Tesco, Sainsbury and Metro).

The intrinsic value is calculated as the average value of the fair prices suggested by the

different multiples. Target price in twelve months period is calculated as the future value of the

intrinsic value given the cost of equity (6.76%).

6 Normalized income was calculated as the sum of the net of tax of abnormal gain or loss on top of the income from

operations before extraordinary items minus minority interest and preferred dividends.


17

Table 5.1: Calculation of Enterprise Value7

Company Name Share Price

(GBX) (13/3/2015)

No of shares outstanding

Equity Market value (GBP) (13/3/2015)

Debt bearing Interest

Cash & Equivalents

Enterprise Value8

WM Morrison

Supermarkets

PLC

204.00 2,335.09 4763.58 2519.00 241.00 7041.58

Marks & Spencer

Group PLC 493.60 1,647.02 8129.69 2303.00 206.00 10226.69

Tesco PLC 232.85 8,122.99 18914.38 13880.00 4901.00 27893.38

J Sainsbury PLC 259.10 1,914.59 4960.70 2989.00 1417.00 6532.70

Carrefour SA 2216.76 707.75 15689.14 10778.20 241.75 26225.59

Metro AG 2215.34 324.11 7180.14 4972.50 3793.60 8359.04

Table 5.2: Fundamental values for multiple valuation

Company Name Equity Book

Value Sales Earnings

Normalised income

EBITDA Income before XO

items

WM Morrison

Supermarkets PLC 3594.00 16816.00 -761.00 40.60 693.00 -761.00

Marks & Spencer Group

PLC 2786.60 10332.90 503.50 486.20 1293.20 502.10

Tesco PLC 13466.00 62116.00 160.00 1904.00 3241.00 865.00

J Sainsbury PLC 5517.00 23932.00 32.00 559.30 1442.00 670.00

Carrefour SA 7942.90 59740.10 1007.00 953.00 3157.20 588.30

Metro AG 3892.50 50490.90 64.50 320.60 1965.60 102.40

Table 5.3: Peers Multiples

Company Name P/E Normalised P/ E P/B EV/Sales EV/EBITDA

WM Morrison Supermarkets PLC N/A 117.33 1.33 0.42 10.16

Marks & Spencer Group PLC 16.19 16.72 2.92 0.99 7.91

Tesco PLC 21.87 9.93 1.40 0.45 8.61

J Sainsbury PLC 7.40 8.87 0.90 0.27 4.53

Carrefour SA 26.67 16.46 1.98 0.44 8.31

Metro AG 70.12 22.40 1.84 0.17 4.25

Mean Value of peers' multiples 28.45 14.88 1.81 0.46 6.72

7 All values are in millions except of share price, which is presented in GBX. 8 Enterprise value is calculated as the sum of Equity market value and debt bearing interest minus cash & cash

equivalents.


18

Table 5.4: Estimation of Intrinsic and Target Price

Mean value of multiple Relevant Value

Morrisons Estimated Intrinsic

EV Morrisons

Estimated Fair Market Value

Morrisons

Estimated Fair Stock Price

Normalised

P/E 14.88 40.6 N/A 604.13 £ 0.26

P/B 1.81 3594 N/A 6505.14 £ 2.79

EV/Sales 0.44 16816 7399.04 5121.04 £ 2.19

EV/EBITDA 6.23 693 4317.39 2039.39 £ 0.87

Intrinsic Price £ 1.53

Target Price in 12 months £ 1.63

Residual income (RI) Model

Recent research has provided evidence that the RI model is superior to other accrual-based

models due to the fact that a great part of the estimated intrinsic value is based on the present book

value of equity. We should further note that due do the recent changes in Morrisons' management,

future dividend policy is uncertain and for this reason DDM could not be applicable.

The inputs of the model are based on the forecasts in section 4, as well as on the assumption

that residual earnings will be constant from year 5 and onwards, as after the implementation of the

business strategy the company will be able to maintain this level. The cost of equity (6.76%) was

calculated using the CAPM with the following inputs:

Risk free rate (Rf)= 1.7%9 which is the interest rate of the 10-year Gilt,

Morrisons’s beta =1 given that food retail is relatively influenced by the state of the market,

Market Return (Rm)=6.76%10, which is the return of FTSE 100 for the last year.

9 Source: http://www.bloomberg.com/markets/rates-bonds/government-bonds/uk/ 10 Source: http://www.bloomberg.com/quote/UKX:IND

http://www.bloomberg.com/markets/rates-bonds/government-bonds/uk/

http://www.bloomberg.com/quote/UKX:IND


19

Table 5.5: Calculations of Residual income model

T 0 1 2 3 4 5 6-onwards

Item/Year 2014-2015 2015-2016 2016-2017 2017-2018 2018-2019 2019-2020 2020 - ∞

Earnings (ER) -761 -648 -593 -333 295 298

Dividends (D)

116.76 116.76 116.76 116.76 116.76

Book value of equity11 (BV) 3594 2829 2120 1670 1849 2030

Residual Earnings (RE)12

-890.95 -784.24 -476.31 182.11 173.01 173.01

Discounted factor (re=6.76%)

0.94 0.88 0.82 0.77 0.72 10.67

PV of RE

-834.54 -688.07 -391.44 140.18 124.74 1845.33

Intrinsic Market Capitalisation (P0)13 £ 3790.22

Number of outstanding shares 2335.1

Intrinsic Price / share £ 1.62

Target price in 12 months £ 1.73

The values calculated using the two methods are very close to each other and clearly suggest

that Morrisons’ stocks are overvalued at the moment. However, the small difference could be

affected by the following factors:

The identified comparable companies may not be as appropriate as expected.

Multiples use historical data in contrast with RI model which uses forecasts. In the first case,

the past may not be appropriate for forecasting the future, especially in the case of

Morrisons, which operates under new management. In the second case, model inputs might

be wrongly estimated.

Both models can have misleading results due to accounting manipulation.

RI model includes the effect of dividend which is not considered in the multiple approach.

The final intrinsic price (1.58 £) and target price (1.68 £) were computed as the average

value of the two methods.

11 Book Value of equity was calculate using the formula: DERBVBV 1101

12 Residual Earnings were calculated as: 1* ttt BVrERRE

13 Intrinsic Value of Equity calculated as:

1t

t00

)r(1

REBVP

t

the sell-side report for wm morrison supermarkets plc

Data & Analytics

uk grocery market

price multiples

p share

igd uk grocery

target price gbp

online channels

largest share

grocery sales channels