Most of the world’s most famous investors – from Warren Buffett to Anthony Bolton in the UK – have been contrarian value investors.
Instead of paying a lot for seemingly great companies, value investors typically buy unloved companies in problematic sectors that are going cheap.
When you buy cheap shares, you don’t need a bold thesis to play out perfectly like you do with, say, a small-cap tech share.
Often you just need things to not get any worse.
Not so super supermarkets
Right now, the UK supermarket sector looks like quintessential value investor territory. Share prices have plunged, and even the man in the street has probably heard these once-mighty companies are feeling the pinch.
I recently looked at why none other than Buffett himself could come shopping for more Tesco shares.
Arguably the most interesting of the bunch, though, is Wm. Morrison Supermarkets (LSE: MRW) (NASDAQOTH: MRWSY.US). It’s the smallest of the major players, and it has the clearest levers to pull to get itself back on track.
But equally it faces the biggest existential threat to its survival as a major force in UK grocery retail.
Morrisons’ revelation earlier this month that it lost £173 million last year sent its shares down more than 10%. Rivals weren’t spared the pain, as Morrisons’ talk of a price war wiped £2 billion off the combined valuation of the Tesco, Morrisons and J Sainsbury .
This was no knee-jerk reaction, either. The shares went down, and stayed down.
The market thinks that Morrisons has to cut prices to compete with Aldi and Lidl, that this will have knock-on consequences for the other major supermarkets’ prices and margins, and that all of them will send more capital out the door as they scramble to refurbish their estates or spend more on promotions to retain their market share.
It’s an arms race, and if not mutually assured destruction it could certainly be for shareholder returns for the foreseeable future.
Cheap not cheerful
But Morrisons does look cheap. At a little over £2, the shares are on a P/E rating of merely 9, with a yield over 6%. Much of the loss recorded in 2013 was an accounting loss, too, so it’s not ridiculous to bet that profits could recover.
However we know that margins are bound to be impacted by the squeeze on prices. Things could get even worse if the company succeeds in attracting business to its new online store, if all that does is cannibalise its own customers.
Also, while Morrisons does have plans to fix things, such as opening more convenience stores and launching a loyalty card, that will all cost money.
I think it’s probably safest to assume the dividend will get cut. Indeed that’s arguably the most prudent way for management to husband funds right now.
Promising property
What’s more, the success of Morrisons’ self-help initiatives is by no means guaranteed.
Perhaps it has lost customers permanently to the German discounters. Perhaps there are no longer many decent sites for new convenience stores. Perhaps it has left it too late to properly tout its strengths such as its supply chain, and affluent customers in the South are happier to trust Sainsbury or Waitrose instead.
Value investors do have one big comfort remaining — Morrisons’ massive property assets, valued at over £9 billion. This real estate more than covers Morrisons’ enterprise value (its market capitalisation plus debt), which is around £7 billion. Theoretically when you buy the shares you get the actual supermarket business for free.
However, it’s not that simple. Who exactly would want this real estate if not Morrisons? If the company had to sell it in a hurry, it would get nothing like £9 billion for it. Retail property is much more attractive when business is going well than when it’s going badly.
Still, the property is by far the best reason to own the shares, not least because it’s attracted hedge fund activists. They have urged the company to unlock the property value through sale-and-leasebacks, and to either reinvest the money in the business or to return it to shareholders. The latter looks particularly unlikely now the company is scrapping for its future, but it does put pressure on the board to be creative.
Morrisons’ hefty property assets also mean the supermarket could be attractive to a takeover by a private equity fund. They could at the least do a more aggressive sale-and-leaseback deal than the grocer could stomach, and they might take other more radical action than a listed company would dare.
Don’t hurry, sale will last
Personally, I can’t make my mind up about these shares. I did invest briefly after they fell on the annual results, but I soon got cold feet.
Investors with a very long time horizon could possibly bag a bargain by buying Morrisons today. Things are bound to be rough and the share price could fall, but we’ve seen enough interest in the company from third-parties to think that they’d pounce if it got too cheap, which may put a floor under the price.
But I plan to keep watching and waiting. I suspect we’ll see more bad news as the price war heats up, and that this could give me a cheaper entry point.
One thing I would not do is buy Morrisons shares for a steady dividend income for years to come. The risks of a cut are just too great.
