Morrisons- Not digging after all

Last week I wrote about the sale by Morrisons of its C stores to My Local. I suggested that this was a clever way for Morrisons to retain exposure in a capital-light manner by continuing to supply My Local on a 'franchise' basis.

Today, My Local have announced a billion pound five year supply agreement with Nisa, so I couldn't have got that more wrong!

This seems to me to be a missed opportunity for Morrisons, and something of a coup for Nisa in a business where scale is important. Without a supply agreement with My Local, Morrisons options in convenience may just have become even narrower.

That's not to say however that the direct operation v. franchise battle is not still raging; in fact it might just have intensified further.

Convenience Food - There are more ways than one of digging for money

In August I wrote about the potential sale of M Local by Morrisons. That sale has now been confirmed, 10 previously closed stores are reopening, and the business is being rebranded My Local - a great name by the way.

In its results announcement today, Morrisons said that

'Convenience remains an important growth channel, and we will continue to consider capital-light, returns-enhancing opportunities in the future.'

Back in August I also mentioned franchising as being a model that could work well for Morrisons. Using its integrated supply chain to better effect by supplying franchised convenience stores seems to make a lot of sense, and neatly fits the returns-enhancing, capital light opportunity that Morrisons is looking for.

In my view we will see the battle for a greater share of the convenience market fought on two fronts now, by direct opening of stores  by retailers; and by increasing use of franchising by national multiples to take market share from the symbol groups. Simply Food is well used to the franchise model and Tesco (using the One Stop fascia) is aiming to open over 180 franchised stores this financial year.

"There are more ways than one of digging for money."

Tesco Store Valuations

Hidden in the announcement yesterday by Tesco of the sale of Homeplus in Korea was  a statement about the use of proceeds that included Tesco's intention to

'consider value accretive opportunities across the group including the selective purchase of some existing leasehold stores in the UK.'

It will be interesting to see whether such a policy will provide a cap on Tesco superstore yields. Theoretically, that should be the case, but the important question is at what yield level purchases are accretive to Tesco - perhaps a case of watch this space.

What would a sale by Morrisons mean to M Local?

Over the weekend, rumours surfaced that Morrisons have entered into negotiations to sell M Local to Greybull Capital. That is not altogether a surprise and I have been saying to potential investors in our new C store real estate fund that an exit was a possibility.

My view is, that in the hands of the right management, there is the core of a successful business here, with 150 stores and the distribution infrastructure to service them. There is a good brand in M Local and provided a mutually beneficial supply agreement can be negotiated as part of the sale I see no reason that a 'franchised' model cannot work both for the new owners and for Morrisons.

After all, It is not a new model in the sector, with SSP Group plc running many Simply Food stores and Tesco increasingly looking to the franchise model for new One Stop openings.

It makes sense for Morrisons to concentrate its capital spend on the core large store estate and to outsource the not inconsiderable capex needed to grow the convenience business. And growth will be key, with in my view at least a doubling of the store numbers needed to achieve critical mass. With each new C store costing up to £1m to convert and fit-out, that is a significant capital commitment.

Of course it is possible that the sale is merely a prelude to a wind-up, but don't bet on it. My guess is that Greybull have long term plans for the M Local business.

Selective Sunday trading reform fails to maximise benefits.........

and potentially puts new investment in retail at risk.

The government's 'Consultation on devolving Sunday trading rules' has been published this morning.

The paper quotes from a study that suggests that there could be a benefit of £1.4 billion a year from removing the existing restrictions across England and Wales. The consultation does not however suggest a blanket removal, but instead suggests that the power should be devolved to local areas. The actual financial benefit of the proposal is therefore largely unknown.

The first option suggested by the paper is that powers should be devolved 'to local leaders, for example metro mayors, through devolution deals.' 

It is unclear exactly who these leaders are, but current proposals for metro mayors appear to cover only large conurbations. Devolving powers in this way would appear on the face of it to leave the majority of England and Wales without a choice over Sunday opening hours and to be focussing the benefits towards towns and cities and away from rural areas.

The second option suggested is that powers should be devolved to local authorities.

In either option the devolved powers will be capable of being applied to specific zones and 'potentially exclude out of town supermarkets'.

It seems to us that there is a fundamental flaw in the thinking behind either of these options in that no consideration has been given to the effect of local boundaries and the effect that different approaches from different local authorities or leaders might have on transport, travel and road congestion.

For instance, if the Wiltshire local authority were to decide, broadly, not to relax Sunday opening hours but surrounding cities such as Swindon, Bristol, Southampton did then it is likely that significantly more journeys would be made over greater distances on Sundays than is currently the case.

We are not sure that would be beneficial.

As well as the transport issues there are site by site cost and value issues to contend with. If, as the consultation suggests, the benefit

 'is generated from lower prices as a result of increased efficiency from shops being able to make more use of existing stores' 

then it follows that stores that are able to open for longer on a Sunday will be more valuable to retailers. They will therefore theoretically be willing to pay a higher rent leading to a higher capital value. 

However if the restrictions can be added or removed at a local level can a retailer or landlord ever be certain about that enhanced value?

Although we accept that, to quote the consultation paper 'Extending Sunday trading hours would ..... support competition and drive economic growth' we take issue with the words 'across the country' that follow. In fact the proposed restrictions would benefit certain areas of the country and not others and rather than supporting competition would be more likely to skew it.

As it happens, we do not have a strong view as to whether the restrictions should be relaxed, but it does seem to us that, if there is an economic benefit to be gained which the government wishes to realise, then it would make sense to capture that for the whole of England and Wales and not just selected parts.

Tesco property values - Still not adding up

Tesco has today announced that, as part of its programme of rebuilding trust and transparency, it is providing 'increased disclosure, including additional details on property valuation and ownership'.

So what has Tesco told us?

It has told us that the estimated market value for its fully owned property was £22.9 bn. Note please that this is an estimate not an external valuation notwithstanding that Tesco later says that "This valuation represents an estimated surplus of £2.7 bn over the year-end net book value".

Tesco also tells us that the £22.9 bn represents a reduction of £7.6 bn year on year. By my calculation that is just short of a 25% reduction in value. That reduction is described by Tesco as 'driven mainly by a significant weakening of the UK retail property market....'

I'm fairly confident that the UK retail property market didn't fall by 25% last year nor did the supermarket sector. In respect of the latter, the latest figures (to 30th Sept 2014) from British Land showed its superstore portfolio growing by 3.1% year on year.

Notwithstanding Tesco's claim of improved transparency, it seems to me that something still does not add up.

Morrisons

I was interested to see that among yesterday's senior management changes was the departure of Gordon Mowat.

There has been much focus at all the grocery retailers on trading performance, but the problems are exacerbated when trading is from the wrong size stores in the wrong locations.

It is easy to blame the 'retail' teams for that, but the reality is that Morrisons, along with its competitors has long needed a property function that is at the heart of the decision making process.

In recent years, far too many retailers have been badly affected or even ceased to exist because their property strategy was too inflexible, (think HMV, Clinton Cards).

Mr. Potts is clearly taking action early to change the business and he should not hesitate to replace Mr. Mowat with a real estate professional who can properly capitalise on the Morrison's largely freehold portfolio, which remains a true competitive advantage for the business.

Monday News

There were a couple of apparently unrelated items that caught my eye this morning.

Firstly, the news reported in The Times that "supermarkets and discount retailers are expected to enter the race to buy BHS".

Despite the fact that many of these stores have planning to allow the sale of food I doubt that the location, size and tenure of the BHS stores will make more than a handful of them attractive for convenience food stores without substantial investment.

I would expect Aldi and Lidl to show most interest. Tesco and Sainsbury less so as they will already be represented in many of the towns where BHS trade. Morrisons may show interest in some if the price is right.

However, in my view a trade sale is the more likely outcome.

The second item was the Q3 IMS from LondonMetric with Chief Executive Andrew Jones highlighting the "greater alignment to the growth of eCommerce through retail led distribution assets and the convenience of click and collect...."

Click and Collect is still strongly preferred by many customers and existing retail locations, close to transport links or houses themselves will continue to benefit from that.

Andrew is right to highlight the benefit of Click and Collect, but the question remains open about how to value that, both for occupiers and for landlords.

If there is an eCommerce value in the BHS trading locations then perhaps these two items are not as unrelated as they first appear.

Aldi and Lidl - Widening the Moat

We have heard much in the media about the threat posed to Tesco, Sainsbury and Morrisons by the rise of the discount retailers.

It is obvious that the annual sales growth that we have seen of 22.6% (Aldi) and 15.1% (Lidl) cannot be sustained without opening a very significant number of new stores. Both businesses have ambitious plans in that regard but opening 30, 50 or 100 new stores per year in the UK will be very challenging.

What strikes me most however is the manner in which both companies talk about the future. Without the pressure of a stock exchange listing and a daily judgement from the market Aldi and Lidl each look to the longer term. Aldi aims to move from 550 to 1,000 stores in the UK by 2022. Ronny Gottschlich of Lidl talks of there being room for up to 1,500 Lidl stores but refuses to be drawn on a time-scale.

That is not to say that Tesco and the other grocers do not have longer term plans, indeed the focus on internet and convenience suggests that they do but the market's focus on quarterly trading performance reduces the scope for true longer term investment.

I am reminded of Warren Buffett's thoughts

"We always, of course, hope to earn more money in the short-term. But when short-term and long-term conflict, widening the moat must take precedence. If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the eight-ball in terms of costs, customer satisfaction or brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted."

Perhaps the listed grocers' inability to widen the moat explains Mr Buffett's recent decision to sell his stake in Tesco and suggests also that the rise of Aldi and Lidl in the UK is set to continue.

Superstore Yields and Rents

Following the recent news flow from Tesco and the increasing competition in the grocery sector, I have been asked a number of times recently about my views on yields and rents.

There has been a noticeable outwards shift in the bond prices of the securitisations that are secured by Sainsbury and Tesco stores, with Tesco's in particular suffering from the downgrade of its rating by Moody's.

Clearly, tenant quality is a factor, but the more important drivers of yield are, in my view, the underlying fundamentals of the property. For that you need to look at demographics, competition, and of course actual and market rental levels.

With retailers starting to scale back new openings (and even exit from existing stores) it is certain that the demand dynamics in the market are changing which will almost certainly have an affect on rental levels. Given that there has always been a shortage of market rental evidence in the sector it is difficult to know exactly how that will feed through. The picture for future rental growth remains unclear, the reduction in supply caused by the reduction in new schemes could be a positive, yet that is also a symptom of reduced demand.

In my view continued price deflation and the consequent margin erosion is likely to put downward pressure on rents, and that is almost certain to have an impact on yields. Investors in RPI linked lease income will need to start to consider the impact on value if indexed linked increases outstrip market rental growth.