Why I’ve finally decided to sell Morrisons

Like banks, supermarkets were once seen as super-defensive investments, capable of delivering steady growth regardless of the economic environment.

That was still the mainstream viewpoint when Morrisons joined my model portfolio in 2013, and even the great Warren Buffett owned a significant slice of Tesco.

Of course, we now know that supermarkets are not quite as low risk as we thought.

Tescos, Sainsburys and Morrisons have all cut or suspended their dividends in recent years and Buffett sold all of his Tesco shares while wishing the company the best of luck for the future.

The problem was not so much that supermarkets are not defensive, because they are. Instead, these supermarkets ran into trouble because of a “perfect storm” of:

  1. Self-induced weakness following a long period of easy growth
  2. A tough economic environment following the financial crisis
  3. Rapid changes to shopping habits which perfectly suited the up-and-coming German discounters, Aldi and Lidl

After several years in my portfolio, Morrisons is still in turnaround mode and I am not especially enthusiastic about its future. However, the share price has largely recovered so I have decided to sell and move on to better things.

  • Purchase price: 293p on 07/05/2013
  • Sale price: 239p on 07/07/2017
  • Holding period: 4 years 2 months
  • Capital gains: -19.8%
  • Dividend income: 17.6%
  • Annualised return: -0.6%
Morrisons share price chart 2017 07
Morrisons’ problems were bigger than I thought and the investment has provided many lessons (but sadly, little in the way of profits)

Table of Contents

Buying what appeared to be a defensive company at a good price

Although supermarkets may seem like slow but dependable blue-chip companies, the period leading up to the financial crisis saw all of the major UK supermarkets growing rapidly. When I looked at Morrisons in May 2013 it had a ten-year growth rate of 17.5% and growth quality of 90%.

This made the company very attractive at first glance, as the chart below shows.

Morrisons PLC - financial results to 2013
Steady long-term growth (if you ignore the blip in 2006)

During that period, the company’s earnings and dividends almost tripled, which is very impressive. However, revenue growth was much slower at 6% per year, which was perhaps a more realistic long-term growth rate for this sort of company.

Overall, Morrisons’ fundamentals were impressive (or at least they were as I interpreted them back in 2013), and its valuation ratios weren’t bad either:

Morrisons PLC - financial metrics table 2013
Above-average growth combined with an above-average dividend yield

Low profitability was a sign of weakness that I missed

One thing that’s missing from the table above is profitability, i.e. ten-year average returns on capital employed. This is an important metric for me today because high profitability is a common feature of high-quality businesses, but in 2013 I didn’t use it at all.

Looking back at Morrisons’ results, I’ve calculated its 2013 ten-year average profitability to be 7.6%, which is quite low. In fact, it’s only just above my minimum acceptable value of 7% and is some way below the FTSE 100 average of 10%.

This isn’t necessarily the end of the world, but this sort of low profitability is usually found in companies that have weak or non-existent competitive advantages, and I think that’s a good description of all the UK supermarkets.

Although this low profitability wouldn’t have been enough to stop me from investing, it would have pushed Morrisons down my stock screen and away from the top ten or 20 stocks that I typically select investments from.

To get back into the top 20 stocks, Morrisons’ share price would have to have been much lower, as the lower (and more attractive) valuation would have offset the company’s relatively low (and less attractive) profitability.

This means that if I had been looking at profitability in 2013, then I would only have bought the company at a significantly lower price than the 293p I actually paid.

That one small change would have massively improved the returns from this investment.

Sadly I don’t have a time machine so I can’t go back and change the purchase price, but I can stick to investing in higher profitability stocks in future (as I’ve already been doing for a couple of years now).

Massive debt-fuelled capital investment was the real killer

In the years leading up to 2013, Morrisons had repeatedly made enormous capital investments (capex) in order to expand and modernise the business.

Unfortunately, I didn’t look at capex back then, but I do now and Morrisons’ capex record raises at least two red flags.

The first red flag was that Morrisons spent more on capex during the ten years leading up to 2013 than it made in post-tax profits.

Having a capex/profit ratio of more than 100% is not necessarily a bad thing, but in most cases, it means the company has to invest lots of cash upfront (to build factories, supermarkets, infrastructure and so on) before it can generate a penny of profit.

This is a risk because it makes expansion more expensive and, once built, these capital assets often come with unavoidable fixed costs, such as maintenance. Fixed costs are then a further risk because they make it harder to cut costs if there’s a fall in revenues.

The second red flag was that Morrisons’ capital investment was consistently more than twice the amount of capital depreciation.

In order to expand and modernise itself, Morrisons spent more than £5 billion between 2009 and 2014 on opening new stores, updating IT systems and improving other operational infrastructure.

In contrast, its capital asset depreciation over that period (which can be used as a rough estimate of the investment required to maintain the company’s existing assets) came to just £2 billion.

So not only was the company investing more in capital assets than it made in profits (capex/profit ratio over 100%), it was also investing more than double the amount required to replace its existing assets (capex/depreciation ratio over 200%).

Clearly, this was a period of massive expansion, modernisation and (hopefully) improvement. These are all things that we usually want, but there are risks.

Too much expansion can lead to oversupply, especially if everyone else (Tesco, Sainsbury etc.) is expanding as well. These days everybody moans about there being too many supermarkets, and the result is an expensive asset which generates weak returns on the capital invested.

Today I have a rule of thumb which says:

  • Don’t invest in a company if its capex/profit ratio is over 100% and its capex/depreciation ratio is over 200%

This would have stopped me from investing in Morrisons because the risk that the company (and the whole sector) was expanding too rapidly was too great.

This situation is made even worse if much of the capital investment is paid for with borrowed money, which is exactly what Morrisons did as it tripled its borrowings from £0.9 billion in 2008 to £3.0 billion in 2014.

Massive capital investment and high debts may be just about sustainable if the economic environment remains helpful, but if the economy falters and sales fall then those high fixed costs will demolish profits in no time at all.

If things get really bad then the dividend and the CEO will get the chop, and that’s precisely what happened at Morrisons.

Holding on as Morrisons begins to repair the damage

Of course, hindsight is a wonderful thing, and if I’d known in 2013 what I know now about profitability, debt and capex, I wouldn’t have bought Morrisons in the first place.

But I did buy the company, and this is what happened:

Initially, things seemed to be going okay as the company focused on its expansion into convenience stores and developing an online presence and delivery capability. These were two areas where Morrisons lagged significantly behind the other big supermarkets, so getting up to speed here was important.

However, by early 2014 it was clear that Aldi and Lidl were benefiting massively from two key changes to the way people did their grocery shopping:

  1. Shoppers were feeling the pinch from the great recession and becoming more value-conscious
  2. They were making more frequent, smaller shopping trips to convenient local stores rather than doing the traditional “big weekly shop” at the weekend

This squeezed all of the big supermarkets, forcing them to reduce prices aggressively to maintain sales volumes, and this squeeze eventually led to dividend cuts at Morrisons, Tescos and Sainsburys.

To some extent then, Morrisons was a victim of external events rather than the perpetrator of an unforced error.

But the previous management team (which was replaced in early 2015) are not entirely innocent, in my opinion.

Some say their biggest error was in trying to go upmarket during the great recession, offering customers misted asparagus when all they wanted cheap baked beans.

That may be true, but for me, there were two big avoidable mistakes:

  1. Going too far too fast with the capital investment program
  2. Loading up on debt so that the dividend could continue to grow at 10% per year

I can understand the desire to improve and expand the company through a program of heavy capital investment, but the dividend policy really stumps me.

Why on earth did Morrisons’ dividend grow from 5p in 2009 to more than 13p in 2015, almost tripling in just six years?

After all, this is a mature supermarket, not a high-growth tech stock like Amazon.

Morrisons’ operations were simply not generating enough cash to keep up with the growing dividend and the massive capital investments being made, so the gap was filled with borrowed money.

Of course, increasing borrowings levers up the balance sheet, lumps the company with a growing interest expense and puts power in the hands of lenders, none of which are good.

Having briefly crunched the numbers, I think a more reasonable dividend policy of 2% growth per year from 2008 all the way to today would have been sustainable.

The company would have held on to more than £1 billion of cash, rather than handing it over to shareholders. Debts could have been more than £1 billion lower and the dividend cut could have been avoided. The CEO and Chairman could also have remained in their jobs.

But the dividend policy wasn’t cautious, the debts did pile up and a large divided cut was required.

Selling because the shares have re-rated while the recovery is far from over

Here’s why I’m selling:

Aldi and Lidl have worked out a way to open smaller stores in the middle of town that still benefit from economies of scale. This local and cheap combination perfectly suits the modern convenience shopper and undermines the local monopoly of the traditional big supermarket.

This means that supermarket margins could be depressed for years, which would not be good for future profits, dividends and share prices.

Clearly, I’m somewhat gloomy about Morrisons’ future, but the market disagrees. The company’s share price has increased by 70% since 2015, despite profits that continue to decline.

This increase in price without an increase in profits has driven Morrisons down my stock screen to where it is now one of the least attractive and lowest-ranked holdings in the model portfolio.

And that’s why I sold the shares earlier today.

Sadly, Morrisons did not provide me with any direct profits. However, like Tesco, it did provide lessons which can be used to generate indirect profits through improved future investment decisions (you can read my post-sale review of Tesco here).

As usual, I will be reinvesting the proceeds of this sale into a new holding next month.

Read the full pre-purchase review of Morrisons in the May 2013 issue of UK Value Investor here (PDF) or read other back issues in the newsletter archive.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

12 thoughts on “Why I’ve finally decided to sell Morrisons”

  1. Your rules about Capex and profits, Do you mean gross or net profits?

    Would Sainsburys be a better supermarket choice after the Argos acquisition? Although I agree that the ROCE and other financial ratios are still awful it might be better going forward.

    1. Hi Andrew, I mean net profits. I should have been more explicit. Typically when I talk about profits I mean normalised post-tax profits,

      As for Sainsburys, it suffers from the same problems:

      Relatively high debt levels (>£2bn compared to typical profit after tax of around £0.5bn
      Average capex of £1bn compared to £0.5bn profits, giving a capex/profit ratio of 2, which is super-high
      Average capex of £1bn compared to average depreciation of £0.5bn, so capex/deprecation of about 2, which is also high
      Average ROCE (profitability) is just 5.4%, which is about as bad as it gets in the FTSE All Share.

      Of course they can cut back capex, which is what they’ve been doing. But to grow that have to invest, so lower capex = lower growth. Or they can acquire growth, which is where Argos comes in.

      I don’t know much about the Argos acquisition so I can’t really comment, but at its current price I wouldn’t want to invest in Sainsburys, and probably not at any price given the amount of capital investment required and the very low returns on capital employed.

      1. Good move – I also made a rather, uneducated at the time, investment in Morrisons.
        In fact I gambled on them twice (in hindsight that seems to be the best description I can come up with) — bought Apr2011 at 279 — sold Sep13 at 311.

        Not satisfied with this I decided to have another go buying again at 234 and 245 in Jan 2014 — I also discovered valuable lessons about looking at ROCE, Capex etc and decided I wanted rid after a very long down period, but was stuck on a loss (I should have sold then maybe) but managed to offload at 234 in Jan17 at a break even point. Overall it was a gain, but a pointless investment nonetheless.

        Sainsbury looks like an disappointment in the making and the purchase of Argos pretty much ensures that they will eventually have all the bones picked from them by Amazon at some future time. Argos margins are lower than Sainsbury and whilst they may cut some costs, I see it eventually collapsing. You only have to look at Argos’s independent trading history to see the value destruction. I’m not sure the SBRY CEO is up to the task.

        Only retail exposure is a low entry into MKS and a few Next before the dividend. Also Card Factory, but I view this as an integrated business not just a retailer.


      2. Hi LR, actually I like Argos as a shop because a) it isn’t Amazon and b) I can order something online and then pick it up in a 20 minute round trip. So I think there will always be a place for Argos (hopefully) but I agree that it’s a shrinking place.

        As for retail, I’m maxed out on UK-focused retail companies. I hold 3 (4 if you count a UK restaurant chain) and I have a rule of not holding more than 10% from any one sector, so 3 out of 30 stocks is the most I’ll hold.

        At least Woodford now agrees with me that UK stocks are attractive, but whether we’re right or not is another matter…

      3. John, I agree with you that Argos has some attractions, however, I’ve long since stopped trusting my own personal tastes with that of the business, Argos’s business has been a real destroyer of value over the last 10 years — jury out of course to see if SBRY can make it any more profitable, or any less loss making, whichever comes first. I doubt it, it’s not going to be radically different.

        I suspect you have made some sensible retail choices around the UK market. I don’t share Woodford’s rosey view and his timing of purchase of construction, property and bank stocks looks as equally ill timed as his investments in RR, NorthWest Bio, Allied Minds, Capita, Centrica ….. Actually I must stop there because the list is too long.
        Take a look at Carillion this morning to realise that the construction (house builders are to be little different as the market tips over the top) industry is not an investment at all but a cyclical play and we are at the wrong end of the cycle.


      4. I sense you’re not a Woodford fan! I think as a value investor he might be suffering in this “flight to quality” market (or “quality bubble” to be less kind). The same sort of thing happened during the dot-com boom. Value investor did badly during the boom, but then massively when the wheels fell off that particular bull market. Perhaps the same thing will happen this time around. We shall see…

  2. Hi John,
    Impossible to win everytime 😉
    The good news is you didn’t sell low, you keep holding and monitoring the story with the stock price.
    However few times I noticed that you never dollar cost average your collapsing stocks. Why not buying more at the maximum of pessimissm ? Then holding with a very long term perspective or selling few months later at the rebound. Maybe it’s what we call deep value investment and therefore not really your style of investing (defensive value).
    Always a pleasure to read your blog.

    1. Hi Eric,

      That’s a good point. In the real world I do add to existing holdings when I’m adding new cash to my portfolio.

      I don’t really think of it as dollar cost averaging (DCA) though. DCA is more about spreading out an initial investment into multiple equal chunks in order to avoid the risk of investing everything at one price.

      What I do in the real world is simply allocate additional savings to whatever existing holdings appear to be attractive at the time, which could include Morrisons at a lower price than the initial entry price.

      The (virtual) model portfolio that I talk about on the website is different. It doesn’t have cash in or out flows, so there are no new savings to be invested. To keep things simple I only make one buy or sell decision for each holding. So with Morrisons I bought the entire position in one go in 2013, didn’t buy or sell any shares in during the holding period and then sold the lot in one go earlier this week.

      I make exactly the same initial and final buy and sell decisions in my real world portfolio, but during the holding period I may top up attractive holdings if cash is available.

      If at some point a stock turns bad, as Morrisons did quite a while ago when it cut its dividend, then generally I wouldn’t top it up. However, this “topping up” part of my strategy is not very strict; I think which stocks I top up is far less important than which stocks I hold in the first place.

  3. Hi John, I don’t consider Woodford as a value investor at all. He tends to buy cyclical stocks at the top of their game, averages down then sells out, coupled with companies with very high debts. His equity income fund has 134 holdings, almost akin to a tracker fund without the oil. Also I think the funds name, “equity income”, is very misleading and I’m surprised it’s not picked up by the trading standards body.
    43 of the holdings are unquoted, not something you associate with income and are highly illiquid. In fact there are more unquoted companies in this fund than in the Patient Capital Trust Fund.
    I fear too many put too much trust in the reputation, without taking due care of what they are actually investing in.

    To be honest I consider your own analysis techniques far more rigorous and thoughtful than Woodford’s.

    LR — I’m no Woodford, but I have my own investment beliefs for better or worse.

  4. Hello John, I really enjoy reading your posts although not an active investor. I am interested in the calculations you used to show the figures on your Morrison’s shares, My wife has an emotional attachment to her M&S shares which she has held for over 15 years and I would like work out how I can calculate dividend income % and annualised return %. I have calculated the average value of the varying prices of the shares she has accumulated, but math is not my strong point. Appreciate your help.

    Kind regards Alan

    1. Hi Alan, as long as you have the info it’s quite easy to calculate annualised returns.

      You need the pence per share and date info on all the purchase, sale and dividend transactions. Or failing that, the absolute value of each transaction instead of pence per share.

      Then you just feed that into a spreadsheet.

      Create a column of dates, from oldest to newest. Then create a column of amounts and enter the amounts for each date.

      Any purchase transaction amounts should be negative because they represent cash flowing out of your pocket. Dividends and sales are positive because they are cash inflows to you.

      Then add the XIRR function to a cell (or field, or whatever you want to call the boxes in a spreadsheet).

      Click here for an example using Google Sheets and my Morrisons transactions.

      XIRR is the “internal rate of return”, which is basically the annualised rate of return.

      If you don’t like spreadsheets then there are lots of online calculators, such as this one (use at your own risk! I just did a quick web search):


      That should do the trick.

      1. Thanks John, I really appreciate your help and for taking the time to explain that for me. I will be interested to do the calculations and see where we stand. I have on many occasions tried to get her to take some profits but she is not interested, perhaps one day.

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