British supermarket chain Wm Morrison reports 8.8% decline in fiscal H1 net profit to £280 million on change in pension costs; sales up 9.1% to £8.1B and like-for-like sales excluding VAT, fuel up 0.9% as consumer market remained 'challenging'

Pauline Vu

BRADFORD, England , September 9, 2010 (press release) – Morrisons better than ever

Financial summary
• Turnover up 9.1% to £8.1bn (09/10: £7.5bn)
• Like-for-like sales (ex VAT and fuel) up 0.9% (09/10: 7.8%)
• Underlying profit before tax up 14% to £410m (09/10: £359m)
• Profit before tax £412m (09/10: £449m after exceptional credit of £91m)
• Net debt £849m (09/10: £885m) after capital investment of £236m
• Gearing of 17% (09/10: 19%)
• Interim dividend up 14% to 1.23p (09/10: 1.08p)

Operating and strategic highlights
• Record weekly average number of customers, up 800,000
• Investing further in food production, a unique point of difference for Morrisons
• Major systems replacement programme on track
• Development of new South West regional distribution centre under way
• First convenience store trials to take place in 2011
• Internet grocery assessment under way

Sir Ian Gibson, Non-Executive Chairman, said:

“Our first half performance has been solid, in a tight market. At a time when value is a priority for everyone we have continued our run of market beating sales growth, attracting more customers to Morrisons than ever before, reflecting our broad appeal. Our new CEO, Dalton Philips, has made a great start in the business and with the leadership team is developing positive plans for the next phase of growth for Morrisons.”

Dalton Philips, Chief Executive, said:

“Over the last six months I have spent time getting to know this great business and its people. Three observations stand out: Morrisons is a world class retailer; it has real and positive differences in its fresh offer, food production and craft skills; and there are many opportunities ahead to drive our top line, increase efficiencies in the business and to capture growth. Today we are outlining plans to build on our strengths and generate profitable growth.

I am delighted to be leading a great company and with the whole team, I am determined to make Morrisons Better than Ever”.

Outlook

We expect low market growth to continue in the second half of the year, with further pressure on the consumer. We entered 2010 anticipating this tight environment, and are managing the business accordingly. We continue to gain new customers and to exercise strong control of costs, and as a result the Board has confidence that we will deliver our profit expectations for the year.

Overview

This report covers trading for the 26 weeks ended 1 August 2010.

Total turnover was £8.1bn, an increase of 9.1% compared to the prior period. Excluding fuel, store turnover was up 5.8%, comprising a like-for-like increase of 0.9% and a contribution of 4.9% from our new stores.

Profit before tax was £412m (09/10: £449m). The prior period included an exceptional pensions credit of £91m and gains of £3m from property disposals. Underlying profit before tax was £410m, compared to £359m in the prior period, an increase of 14%. The operating margin of 5.2% was up by 10 basis points from the prior year primarily reflecting the  benefit delivered by the Group’s new South East RDC opened in 2009.

The Group generated positive cash flow of £98m before repayment of borrowings. This compares to an outflow of £238m in the same period last year when there was a high level of capital expenditure arising from the acquisition of 38 stores from the Co-Operative Group. Cash generated from operations was £580m, an improvement of £47m over the prior period. Net debt reduced by £75m from the year end position to £849m, to leave gearing at 17%.

During the period a 250m (£150m) bond was repaid using the Group’s existing credit facility. At the period end £650m of this facility remained undrawn. Throughout the period the Group operated 425 stores, with 11.9m square feet of net selling space. Our new stores programme will see 15 stores open in the second half, adding a further 0.4m square feet to the estate.

The Group’s dividend policy, as previously announced, is to maintain a payout ratio consistent with the European grocery sector average and to grow the dividend in line with underlying earnings. The Board is therefore pleased to confirm its intention to increase the interim dividend by 14% to 1.23 pence per share (2009/10: 1.08p). This will be paid on 8  November 2010 to shareholders on the register on 1 October 2010.

The UK grocery retail market
As anticipated, the consumer environment has remained challenging, with disposable incomes coming under pressure from a rising tax burden and consumer confidence impacted by concerns over unemployment and public sector spending cuts. In the grocery market, pressure on the consumer was eased through the virtual elimination of the food price inflation seen in the previous two years. Additionally, the highly competitive nature of the market saw a record level of promotional activity. Market growth in the first half was 3.0 %, whilst Morrisons equivalent growth was 5.8% (source: Kantar). This level of market growth was the lowest for five years.

We anticipate a similar low level of market growth in the remainder of 2010, although with a slight rise in prices due to the re-emergence of some commodity price pressures. For example, wheat prices are currently more than 60% above 2009 levels due to poor harvests, and oil has risen 13% in the past 12 months. Higher wheat and grain prices lead rapidly to increases in bread prices, and in the following months to higher protein prices as the costs of animal feeds rise. Higher oil prices affect most products as a result of higher costs of distribution and packaging.

Morrisons strong value credentials and focus on high quality fresh foods leave us well placed to continue to be  successful in a low growth environment in the coming 18 months. In considering our strategy for growth, our financial strength allows us to look through the recession in order to invest for the long term.

We believe the UK grocery market will continue to offer attractive growth in the medium to long term. The UK population is expected to grow at a higher rate in the coming ten years, and the pre-recessionary trend towards healthier eating and concern for the provenance and quality of food will strengthen again as the economic recovery takes hold. The long term trend of food expenditure falling as a proportion of GDP reversed in the past two years, and we believe it is likely to continue to rise given the growing global demand for commodities.

Trading
Our total store sales growth of 5.8% and like-for-like growth of 0.9% were once again ahead of the market. The squeeze on consumer disposable income was reflected in a marginally lower (0.2%) basket spend in like-for-like stores, although
the strength of our offer saw a 1.1% increase in the number of customers visiting these stores. Overall, including  customers visiting our new stores, there was an 8.0% increase in total customers with a record average of 11.1m visiting our stores each week.

On our forecourts, the rise in the price of oil, exacerbated by sterling weakness and a rise in fuel duty, meant that consumers were paying on average 17p per litre more at the pump than in the previous period, with average unleaded prices per litre of 115p. This represented a £240m adverse effect on the disposable income of our customers. Our strong value positioning in the market attracted more customers onto our forecourts with total unleaded and diesel litreage up 4%. Overall, like-for-like fuel sales were up 23% in the period.

Although the economy has started to show the first tentative signs of recovery for the consumer, the prospects of a higher tax burden and a background of rising unemployment have continued to undermine confidence. Saving has become a more important consideration for many than spending. In this challenging environment Morrisons continuing strong focus on its quality and value offer has, for the third year in a row, enabled us to deliver sales growth ahead of the market. The fresh products offered in Market Street continue to perform well, reflecting our sharp everyday pricing and extremely  attractive promotions. We have continued to exploit the flexibility delivered by our food production facilities, coupled with specialist food preparation skills that our competitors cannot match.

The market remained highly promotional during the period, and we ensured that Morrisons continued to offer the broadest range and greatest depth of promotional discounts in the market. Whilst some promotions were aimed at giving our customers affordable treats, such as a very successful Pimms promotion, most were designed to offer savings on everyday essentials. Our promotional offers with milk and bread at 50p and fresh fruit and vegetables at 30p, representing the lowest priced staple products in the country, were extremely popular. Our volume momentum has been ahead of the sector for a sustained period and has enabled us to invest strongly in value for our customers, both in base price and in the promotional programme. Towards the end of the period we launched our new television advertising
campaign. This continues the strong emphasis on the provenance, quality and freshness of our food and on our in-store skills, with food stories told to school children. Early research from the campaign has shown it to be highly effective.

Strategy update and operating review
In 2009/10 the Group opened 43 new stores, including 34 acquired from the Co-Operative Group and converted to Morrisons after complete refurbishment. The management and staff of these new stores have continued to establish Morrisons reputation for quality and value in areas of the country where we were underrepresented, and their operational performance has been very much in line with our projections at the time of the acquisition. Our expansion into new areas of the country continues successfully, through the National to Nationwide programme. We reiterate our space expansion target of 1.5m square feet in the three years to the end of January 2013.

The development of our new South West RDC at Bridgwater is now underway and the site will become fully operational in early 2012. This is a few months later than we had originally planned, due to delays experienced by the site developer in achieving a viable total scheme for the site, which depends also on residential development that has proved challenging given the state of the housing market. Our facility will be freehold, and at 800,000 square feet will serve 63 stores and provide further capacity to support our National to Nationwide expansion. The total investment will be £95m.

Our supply chain is key to enabling us to deliver a unique fresh offer to our customers and really demonstrating that we understand the provenance of our food. We previously announced that we were reviewing further opportunities to expand our manufacturing operations and in the period we made two investments:

• We acquired a stir fry and prepared vegetable business for which Morrisons was the biggest customer, but which had significant further capacity. This will enable us to consolidate our sourcing of all these products in house.
• We acquired a cooked meat production plant which will add to our existing capacity and allow us to produce nearly all of our requirements in-house.

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