Questor share tip: Morrisons downgraded again

The last time we looked at Morrisons we warned the dividend could be cut and that investors were at risk from a fall in the share price. If anything, the situation has now got worse.

Management at Morrisons has pledged to increase dividend payouts and cut prices in its stores, but this doesn’t look possible. Market consensus is for underlying pre-tax profits to halve to £325m by February 2015 from £785m last year.

The sharp drop in profitability will see adjusted earnings per share fall from 22.7p in January 2014 to almost 12p in January 2015, which doesn't even cover the 13.7p dividend per share.

We will get an idea on trading in the first half of the year next week. Management said it would increase dividends by 5pc this year, and has moved to protect the payout by cutting spending on new stores in half to about £500m this year.

The supermarket group has also said it will sell off sites worth almost £1bn over three years, with the first of these sales expected at its interim results.

Beyond this, a cut in the dividend now looks almost a certainty. Questor believes the most likely option would be a 50pc cut to around the 7p level, from where it could be steadily rebuilt.

Management predicts that dividend payments, which equal about £318m in cash each year, should be affordable as they will be covered almost three times over by free cash flow of about £900m.

Morrisons shares currently trade at 173½p, which is about 15 times the adjusted 2015 earnings per share of 11.9p.

Given that profits, and therefore earnings per share, are not expected to grow for the next three years, a rating of 14.7 times looks high. Arguably, it should drop to around nine times earnings, or an estimated stock price of 140p per share. Sell.

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