3 Reasons I Might Average Down On Wm. Morrison Supermarkets plc

An alternative approach to valuation strengthens the buy case for Wm. Morrison Supermarkets plc (LON:MRW). The Motley Fool has recommended Wm. Morrison Supermarkets.

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Should you buy more shares and average down, or should you sell?

Morrisons

That’s the dilemma facing many Wm. Morrison Supermarkets (LSE: MRW) (NASDAQOTH: MRWSY.US) shareholders — and it’s certainly a debate I’ve been having with regard to my own shareholding.

In this article, I’ve taken a look at three factors that I believe should provide support for Morrisons’ current valuation, meaning that any recovery in sales could trigger decent gains.

1. Asset value

There’s no doubt that Morrisons’ £9bn property portfolio is a key element of its current valuation, and this is highlighted by the fact that the firm’s share price is within a few pence of its net asset value — it’s theoretical liquidation value.

2. Replacement cost

Investment valuation often focuses on relative valuations such as the price-to-earnings (P/E) ratio, where ‘cheap’ and ‘expensive’ depend on market averages, which change over time.

An alternative approach to valuation is to think like a trade buyer, and look at the replacement cost of a firm — would it be cheaper to buy the existing business, or to build it yourself?

In addition to its £9bn property portfolio, Morrisons has a well-known national brand, which is strongly identified with good quality fresh produce and family values, and which generated sales of £17.7bn in 2013/14.

The current price tag for all of this is about £7.5bn, which is Morrisons’ enterprise value (market cap plus net debt). There’s no way that anyone could create a competing business for that amount of money, so Morrisons looks cheap as a potential takeover target.

3. Tax savings

Morrisons could also be an attractive takeover target for a different reason — tax. The supermarket could offer significant savings to a US firm wishing to cut its tax bill by moving its tax base to the UK, a manoeuvre known as tax inversion.

It may be politically unpopular, but the financial logic is clear: US companies usually pay corporate tax at 35%, whereas the equivalent rate in the UK is just 21%. As we saw with Pfizer’s failed takeover bid for AstraZeneca, tax inversion can be a big motivator in a deal, and Morrisons would be easily affordable for a number of potential US buyers.

Still risky

However, Morrisons remains risky: sales may continue to decline, the firm’s 6.5% dividend yield looks vulnerable to a cut, and it’s always risky to rely on takeover bids for your investment profits. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland owns shares in Wm. Morrison Supermarkets, but not in any of the other companies mentioned in this article. The Motley Fool has recommended Wm. Morrison Supermarkets.

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