Morrisons : Full year results

11:45 a.m. Wed 23 Mar 2005

A strong performance by the core Morrisons chain was partially offset by the poor performance of Safeway. Core Morrisons sales were up 11.3% while operating profits (before exceptionals and goodwill) were up 36%. Including the contribution of former Safeway stores, sales were up 148% to £12.3bn while operating profit was up 20.4% to £380m: Core Morrisons generated an operating profit of £430m while former Safeway stores made a £49.5m operating loss. The loss from Safeway, and the interest payment in 2005 compared with the interest received in 2004 meant that pre-tax profit was 1.6% lower at £325m.

A week ago, Morrisons said that it will create a provision of £40m relating to "supplier balances". Safeway used to account for fees from suppliers up-front where as Morrisons record this income when it is earned. Morrisons made the £40m provision as it was unable "to prove, in respect of certain amounts, whether these balances arose pre or post acquisition". Morrisons is yet to bring Safeway’s accounting systems in line with Morrisons, a somewhat worrying situation given that Safeway was acquired in March 2004.

Morrisons 11.3% growth was helped by a 4.6% LFL sales growth, which is below Tesco's (7.0% to 7.5% LFL growth). Since conversion, former Safeway stores LFL sales were up 9%, while those yet to be converted performed poorly with LFL sales down 8.9% In the first six weeks of the 2006 financial year, the decline in LFL sales at the unconverted Safeway stores reduced to 0.5% while converted stores performed well (LFL sales up 11.3%). However, worryingly core Morrisons LFL sales were down by 1.2%. Morrisons said that cannibalism from converted Safeway stores and tougher competition from those that were disposed of (under new owners) reduced sales: Hence these same factors may affect the performance of the core Morrisons chain in the current year.

The conversion is going well, with 57 stores converted during the year (to January 2005) bringing the total conversions to 84 by 23 March 2005. Morrisons plans to convert c140 stores during the remainder of the year brining the conversion to 170 stores in 2005/06; i.e, The conversion would largely be complete by the year end except for c85 stores which Morrisons may either sell or convert to the Morrisons format. The converted stores reported good LFL sales growth with an increase in both customer numbers and their spending.

The fall of gross margins from 25.5% to 24.4% is due to the performance of Safeway. Safeway had a gross margin of 22.9% compared with the 26.1% gross margin of Morrisons. Safeway has much higher staff costs and higher operating expenses which demonstrates the room for improvement. Should former Safeway stores achieve the operating margins of the core Morrisons stores, total company profits would more than double: but this is unlikely to happen in the short term with conversions costing more than what was originally anticipated.

Morrisons' share trades at a prospective PE of 15.4× (at 200.75p) in line with the sector. The 2.2% yield is at the lower end of the range for the sector. The rating reflects a probable recovery of Safeway. The lower LFL growth (compared with those of Tesco's first three quarters) is a concern particularly as Tesco and Asda continue to cut prices-Morrisons will be forced to follow. The integration of Safeway and Morrisons is another concern. Morrisons has a good track record, and if it repeats it with Safeway, the share will trade at a single digit multiple of earnings.