The brief period of euphoria following the consummation of the deal between Safeway and Morrisons came to an abrupt end last month when Sir Ken Morrison issued his first profits warning in 37 years.
His admission that “profits for the current year will be substantially lower than current market expectations” crystallised many City analysts’ doubts about the progress of the difficult integration of the two businesses. Their collective response was to forecast reduced profits in the region of £150m to about £375m for the full year.
No one thought the integration would be quick, but just how long is it going to take?
Clive Black, director and head of research at investment bank Shore Capital, says: “The challenge is enormous and the time taken to do it will be lengthy. And they are not up against Daffy Duck - it is Tesco and Asda, which are huge competitors, and it will take some time for Morrisons to show that it is on top of things.”
Estimates extend to as long as four years before the company is again firing on all cylinders. Mike Dennis, food analyst at Cheuvreux, puts some of the integration problems down to Morrisons not really understanding the Safeway business, including the mechanics of its Wednesday promotional flyer and the supplier rebates that were helping it achieve “false levels of profitability”.
Morrisons believes it can offset these shortfalls by volume gains once it has converted all the Safeway stores to its yellow Morrisons format. But there is some scepticism over whether the conversions will achieve the necessary uplifts across the whole estate.
One analyst at a major investment house, who does not wish to be named, suggests the 36.8% sales uplifts enjoyed at the first few converted stores are unlikely to be duplicated across the whole Safeway estate. “Refit programmes always start well and end badly,” he says, bluntly.
Part of the problem, he suggests, is down to as many as 20% of Safeway stores having little competition, which means it will be difficult to achieve any uplifts at these outlets, since they already have the whole market in their respective areas.
Tom Gadsby, food analyst at stockbroker Williams de Broë, agrees it will be hard going to achieve the 25% across-the-board increases that Morrisons requires if it is to support the hefty 8% price cuts it has introduced in all the Safeway stores.
Black also has reservations: “We remain to be convinced that the conversions will do it. They are not core Morrisons and the difference is basically Market Street.”
He says the Market Street format is built into the core of a Morrisons store, with sufficient backroom space given to food preparation, but at some converted stores they are a “hybrid and not a full replication because of constraints on space and trying to use cash carefully”.
The sheer variety of store sizes acquired by Morrisons is not helping, says Gadsby. He adds: “It has run a niche business in the north of England, where 90% of its sales are, and stuck rigidly to 40,000 sq ft stores. But now it has cornershops and up to 90,000 sq ft hypermarkets.”
Paul Smiddy, from RW Baird, adds that the company also “found the fabric of Safeway stores worse than it thought”, which has pushed capital expenditure up by about 20%. This will eat into the synergy savings - estimated at £250m - it had earmarked to fund its price cuts programme.
This shortfall will put the group under pressure as Tesco and Asda continue to reduce their prices. Morrisons will not only have to reduce prices, but do so with the same vigour as its major competitors.
Analysts question whether it will be able to achieve the same margin as a national player that it has enjoyed in the north for years.
As it tries to work on the southern end of the business it dangerously runs the risk of neglecting its heartland because of its “under-staffed” management, says Smiddy.
“There’s an unwillingness by Sir Ken to expand the management base. The team is spread too thinly and my concern is that it will mean the integration will not progress as comprehensively,” he says.
Another result of being all-hands-to-the-pumps is that there has been little guidance from Morrisons as to what its full-year performance figures are likely to look like.
One of the few things known is the postponement of Morrisons’ interim results from September 23 to the second half of October. At this point, Dennis expects like-for-likes sales at Safeway stores to be down by only 4-5% - compared with the 7% Morrisons announced in July.
But beyond that the company is providing no guidance on future trading. “There is obviously no visibility for them, so there is none for us,” he says.
Such is the high regard in which Sir Ken is held by City analysts, they unanimously expect him to deliver the goods. But the timeframe for this now looks longer than initially expected. Until the picture gets clearer a cloud of negativity will remain over the company.
What the city thinks
>>How top city analysts rate morrisons
View:Mike Dennis, food analyst: “We did not like the deal because Morrisons did not understand the business and integration will take longer than expected. Finance director Martin Ackroyd does not expect operating margins above 5% in the next four years, which is a slower recovery than some expect. Morrisons is nursing Safeway back to health, but the care might not be as good now.”
View:Paul Smiddy, retail analyst: “We’ve had this rating since May, before the profits warning, and I think the Christmas trading period will be maximum stress for Morrisons.
“I thought Safeway was less robust than Morrisons did. The initial integration has not been smooth.
“It’s clear Safeway customers went there for big promotions so throwing them out wholesale was not a good idea.”
View:Clive Black, director and head of research: “We’ve not had a Buy rating since January as we felt Safeway was a large task to take on. We wanted to see that the end execution was met and our cautionary stance proved right. Morrisons was disappointed with what it found at Safeway and we’ve been disappointed by its level of disappointment. It will take time to demonstrate it’s on top of the integration.”
Williams de Broë
View:Tom Gadsby, food analyst: “We’ve been sellers for a long time before the profits warning as we always thought it was the emperor’s new clothes. Morrisons was looking at like-for-like increases of 10% as well as £250m of synergy benefits and it would have this wonderful creature. But it has come a cropper. In three years’ time it will probably do it but it has no experience of integrating businesses.”