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Morningstar | Wholesale Leads the Way for Morrisons as Competition in U.K. Grocery Market Intensifies

Although operating margins in the grocery industry are similar among the Big Four companies, we reckon Morrisons has a more efficient operating cost structure than Tesco and Sainsbury’s. Further, the firm has a stronger balance sheet than its Big Four peers, with no pension deficit and a higher percentage of store ownership. Still, what the grocer saves from a less dispersed store network (mostly in Northern England), it gives back through lower scale and buying power relative to larger competitors; Morrisons is only the fourth-largest U.K. grocer with around 10% market share, according to Kantar.Morrisons predominantly has large-store exposure, with no convenience-store presence and an online channel growing through a third-party partnership with Ocado. Its strategy is centred on driving traffic in stores through the provision of additional services such as hand car washes, tyre change concessions, and parcel pickup services on top of a stronger core food offering. Further, the company targets higher exposure in growth channels through capital-light partnerships in wholesale (Amazon, McColl’s), online (Ocado), and convenience (Rontec forecourts). Although we believe management’s plan makes sense in the current market environment, it highlights the company’s poor channel offering in an emerging multichannel world. We view the company’s channel positioning as problematic despite the new initiatives, especially in a period of balance sheet deleveraging and tighter capital expenditure budgets (making it hard for the firm to develop its own convenience-store network).Morrisons’ medium-term cost-saving target is uninspiring; at GBP 75 million-125 million, the objective is lower than that of Tesco and Sainsbury’s as a percentage of sales (0.2% versus 0.7% and 0.6%, respectively, on an annual basis). This is partly due to the company’s already efficient operations, which offer little room for incremental cost extraction. While Morrisons’ strategy of diversifying its channel exposure is logical given the circumstances, strong initial results are off a low base and shouldn’t be enough to offset competitive pressures from discounters and its Big Four peers.