When it comes to Morrisons, we doff our caps to the sales growth number, but won’t be upgrading as the second half will be even tougher. Elsewhere we think prices, margins, forecasts and valuations are under severe risk. We are worried about the prospects for Morrisons, Sainsbury’s and M&S as we fear forecast downgrades ahead. A profit before tax outcome of £295m at Morrisons was midway between our forecast and market consensus, but the company got there in an unusual way. Like-for-like sales growth was miles above our expectation in Q2 (8.2%, an acceleration on Q1) but the margin picture was not what we had in mind . What is perceived as the retailers’ friend, inflation, can be quite the opposite and, at present, input prices are rising quicker than shelf-edge prices.
This differential inflation is pressurising gross margins and it is only the efficiency work that Morrisons is conducting that has allowed operating margins to progress at all (despite such strong sales growth). Other companies in the sector, where sales volumes are negative, will find it very hard to deliver on estimates. Morrisons (and we) predict a continuation of the current dark consumer environment. Our view is that like-for-like sales growth will slow in H2 (we have 4% in our forecasts for the period) and that margin progression will be modest at best. This is not to say that Morrisons is actually doing anything wrong, quite the opposite. Widening the value brand and tertiary offer is sensible and the marketing campaign continues to be effective.
The UK supermarkets’ sector is just a tough place to try to grow profits these days. It may be that Morrisons actually shows the best sales and profit growth in the sector this year and next but the valuation of the shares demands continued upgrades for City estimates and we think they are very unlikely. Hence a downward trend in share price is more likely from the current rather punchy 257p. We are also cautious on JS and M&S, and Tesco is unlikely to impress either. Investors should fish in non-food retail waters right now.
Jonathan Pritchard is a partner at Oriel Securities