“Fears over Morrisons estate being sold on cheap…The shops, warehouses and factories owned by Wm Morrisons could be worth almost £9 billion – double the value the supermarket chain believes they are worth, raising concerns that a buyout firm could seize the assets on the cheap.” – Times 7 July 2021
So what is the value of Morrisons property portfolio and should this inflate the price that bidders pay for the company?
Morrisons balance sheet shows a historic net book value (NBV) of £5.8bn of its freehold land and property. Of course, the Morrisons board knows that the current ‘open market’ value, based on willing seller and willing buyers, is probably higher than this. However, this is just not relevant, as at the moment there is no willing seller and few buyers, and even the latter probably couldn’t buy the stores.
Suppose that Morrisons, with new owners, wanted to sell its property portfolio. Any significant disposal of its stores would attract the close attention of the Competition and Markets Authority (CMA). Given the oligopoly of the large supermarket operators, and not least the report on the Morrisons/Safeway merger in 2004, it is very unlikely that any significant divestment of stores would be allowed by the competition authorities. The obvious buyers of the stores – and the only ones who could pay top dollar – are the other big players, exacerbating competition concerns. Even they are far less keen to buy new stores than they used to be, with the pandemic and rise of home delivery making new space both less profitable and less essential.
If Morrisons tried to sell for alternative use value – non-food retail, offices or residential – the value is likely to be much less, especially in the current environment. It would be a brave buyer to believe that this value would be higher than book value.
If the CMA did allow Morrisons to divest its store portfolio, where would that leave the retailer? Morrisons has missed out on the online/home delivery boom, increasing its reliance on physical stores. Why would financial buyers pay big money to buy a retailer and then shrink it down by selling stores? Food retail is a scale game. Even private equity couldn’t shrink its way to profitability.
If open market value isn’t appropriate in valuing the property portfolio, how do we put a price on it? Since they can’t in practice sell the stores, the value can only be the value to Morrisons. The new owners could sell the properties and lease them back. This would be one way to crystallise the value.
The limiting factor for a sale and leaseback is not the open market value of the properties, it is the affordability of the rent. A landlord will not buy a supermarket (or depot) if it doesn’t believe that the tenant can comfortably afford the rent. The capital value is a much lesser factor. A landlord will probably want around a 4.5% yield (this varies by age/location). If Morrisons new owners want to sell the property portfolio for £6bn, they will need to be able to afford a rent of £270m pa. If they can afford, and want, to pay a rent of say £400m pa, a landlord might agree to pay a capital value of £8.9 bn. The capital value is determined by the rent, not vice versa.
How much extra rent could Morrisons afford? In its last financial year, to January 2021, Morrisons made £201m before exceptional costs, a big drop on the prior year, when it made £408m. The £201m profit was affected by nearly £300m in extra costs from the pandemic. Let’s assume that the underlying rate of profitability is say £550m pa, suggesting that the most they could afford is something like £200m – £250m extra rent pa. At a 4.5% yield, this would release something like £4.4bn- £5.5bn.
Some of the buyers have said that they wouldn’t sell and leaseback significant numbers of stores, but left open the possibility of selling or leasing depots and manufacturing facilities. They might in fact prefer simply to mortgage the stores, raher than sell and leaseback. They might be able to secure financing at perhaps an interest rate nearer 3%, much less than the 4.5% rental yield in a sale and leaseback. It also would enable them to keep control of the stores, rather than have to deal with landlords (this is a significant issue for food retailers). The lower interest rate could enable Morrisons to release more cash, but they would end up with tight covenants to protect the interest of the lenders.
It’s too easy to dream of large capital values without thinking about the extra rent or interest. If a new owner plans to sell property, this would give them a big cash inflow, say £5bn. However, it also reduces Morrisons profit by £225m pa. If the whole business is valued at, say, 15x annual profit, this would then reduce Morrison’s value by £3.4 bn, assuming that the multiple was not reduced by the increased risk from leverage. The net ‘value’ release would be £1.6bn, and the new owner would subsequently have to bear a much more geared profit and financial risk.
The massive property values being ascribed to Morrisons are not real. They assume that the property could be sold to other food retailers, which is highly unlikely, and ignore the trading impact that disposing of store would have on the business. The value that investors should look at is the affordable rent, and how much cash or debt that could release. Given Morrisons profitability, the release of value would be relatively modest. Even then, they might do better to use the property as security for debt, rather than sale and leasebacks.
The message however is clear. The key to Morrisons real value to shareholders is its future profit flow, not its property.
There is much more on how boards value their own companies and corporate acquisitions, with plenty of discussion of Morrisons, in my new book ‘Behind Closed Doors. The boardroom’ available from all leading bookstores, including Waterstones and Amazon.