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Questor share tip: Morrisons 6.7pc yield only for the brave

The Bradford-based supermarket chain is now offering a 6.7pc forecast dividend yield but it is high risk, says Questor

Morrisons’ like-for-like sales have declined by 0.8pc in the four weeks ended December 8, according to Kantar.
Morrisons’ like-for-like sales have declined by 0.8pc in the four weeks ended December 8, according to Kantar. Credit: Photo: ALAMY

Wm Morrison
207.4-0.6
Questor says HOLD

SHARES in Wm Morrison may be down 21pc so far this year but they present investors with the tantalising prospect of a 6.7pc dividend yield.

Be warned, though. That high income could come at a high price. Some analysts believe the dividend is under threat as profits at the Bradford-based supermarket tumble amid a price war. The shares could also have further to fall, leading to sharp losses in the value of any holding.

So, just how sustainable are the dividend payments as profits drop?

Management at Morrisons has pledged to increase the payouts by 5pc this year but the supermarket chain has also said it will cut prices, which will slash underlying pre-tax profits from £785m in the year ended February 2014, to as low as £325m by February 2015.

The sharp drop in profitability will see adjusted earnings per share fall from 22.7p in February 2014 to almost 14p in February 2015, which will barely cover the 13.7p dividend per share.

Usually, when the earnings cover on the dividend is this slim, the dividend is cut but Morrisons is different as it is still generating plenty of cash.

Cashflow is also set to rise sharply during the next two years. Morrisons had been spending about £1bn in cash opening new stores. That expenditure will fall by about £500m this year and another £100m next year.

The supermarket group is also sitting on property worth about £9bn and has said it will sell off sites worth almost £1bn over three years. This should generate an estimated £450m in cash this year and about £250m in each of the next two years.

So, while Morrisons’ profits will fall, cash will flood in. The group had net debt of £2.8bn at the end of February 2014. This is forecast to fall to £2.3bn by February 2015 and £1.9bn the next year.

As a result, dividend payments, which equal about £318m in cash each year, should easily be affordable as they will be covered almost three times over by free cashflow of about £900m.

On these numbers the dividend looks safe but the same cannot be said for the value of any shareholding in the supermarket. Shares currently trade at 208p, which is about nine times the adjusted 2014 earnings per share of 22.7p.

The supermarket price war is expected to push Morrisons’ earnings per share down to 14p next year, which means the shares are currently trading on 14.7 times earnings.

Given profits, and therefore earnings per share, are not expected to grow for the next three years, a rating of 14.7 times looks high. Arguably, it should fall to around nine times earnings, or an estimated stock price of 140p per share.

The only thing stopping the share price from plummeting is the promise of a healthy dividend. A share price of 140p would pay a dividend yield of about 10pc.

Morrisons cannot continually pay dividends at this level by selling off property as profits fall.

The company also cannot cut spending on new stores and use the spare cash to lower prices, as it will get squeezed out of the market by fast-growing rivals.

However, what Morrisons can do is cut prices, get customers back into stores, take on discounters Aldi and Lidl and then slowly repair profitability.

The worst case scenario for investors is Morrisons’ rivals cut prices and the supermarket is left in a similar position but with profit margins about half what they were. This is a risky situation for investors but that is why income of 6.7pc is on offer for those brave enough to believe Morrisons and, more importantly, the dividend can come out the other side in one piece.

Questor thinks the first rule of investment should always be to protect capital and we downgraded the shares last year (256.75p, Hold, December 18).

They remain no better now. Hold.