Our companies analyst reckons there’s potential for a profitable turnaround if this convenience store operator can come up with the goods.
This is a high-risk speculation, but the reported progress being made by McColl's (LSE:MCLS)’s in rolling out Morrisons Daily stores make the company worth understanding, ahead of a trading update for its financial year to 28 November 2021, which is due on 8 December.
Going for broke with the new convenience stores
“We will also provide greater insight into the performance of the Morrisons Daily format…” I imagine the firm’s PR advisers will pull out the stops to say how well these stores are doing, as a counterbalance to recent bad news about supply chain disruptions. Logically, they should indeed be doing well, otherwise Morrisons would not be on board with building up wholesale supply.
Moreover, this week has started with positive news: the conversion of McColl’s newsagents/stores to Morrisons Daily stores is to be extended from 350 to 450 by end-November 2022.
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That is a second advance on the 300 stores targeted by end-2023, set last summer. Morrisons has plenty vested in this gambit, with its own brand name on the line, and therefore a strong incentive to make it work. Cynics might not unreasonably point out, however, that that includes eventually acquiring McColl’s stores from an administrator.
A wholesale supply contract with Morrisons has been extended by three years to January 2027, and is said not to be affected by private equity taking over the supermarket group. Morrisons is the single supplier across McColl’s estate, after some 300 stores acquired from the Co-op in 2017 came to the end of a contract with grocer Nisa.
Technical situation in the stock may tilt to buyers
In the short term at least, supply disruptions may be “in the price”, which has fallen to 12p after a 20p placing and open offer last August raised around £30 million net, to help accelerate the new formats. Be aware, these need to work sufficiently well in the longer term to make McColl’s finances more manageable.
But my current reason to pay attention to the stock is that it is at least possible the balance of trading in McColl’s shares will tilt to buyers, if the 8 December update portrays a situation that has stabilised financially and where marketing is gaining traction.
Last August, the CEO subscribed for £3 million in the share offer, indicating that aside from recent supply disruptions he was confident in the turnaround tactics being deployed.
There is at least a scenario where 8 December proves to be the trough, although I concede the best-case is probably going to involve further dilution in the longer run – mitigated by a share issue at higher prices, hopefully, given the extent of liabilities.
McColl’s has also yet to demonstrate worthwhile margins, although that could come if the convenience stores’ transformation works.
Morrisons supermarkets have appeared well-stocked
A curiosity about the “disruption” story within the 17 November update, which was responsible for the stock plunging from about 20p to 12p, is that Morrisons has no apparent problems. There are several such supermarkets in my locality and the only gap on shelves I have witnessed is the large box of own-brand, non-bio washing powder – recently fulfilled.
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A harsh explanation is that Morrisons has prioritised its own estate, such that McColl’s 17 November update cited “intensified” supply chain disruption due to shortages of both personnel and key products – including high-margin lines.
There are anecdotal reports, along lines of “you would be surprised at the extent of beer and crisps these convenience stores sell,” and indeed Walkers Crisps has owned up to a supply shortage of its own, although this is said to be due to an IT glitch rather than any shortage of potatoes.
At least if the issue involves specific items and McColl’s credibility is now on the line with investors, management should be moving heaven and earth to resolve it. Only a couple of months ago we were told the fuel shortage would persist, but suppliers swiftly got their act together.
Despite McColl’s warning of “significantly” lower revenues from this debacle, circa £20 million EBITDA (which is close to operating profit) for the latest year to 29 November hardly sounded a disaster.
But the dilemma for intrinsic value is where any positive tipping point exists, when the group has substantial liabilities.
£323 million debt within circa £35 million net assets?
The interim balance sheet had £16 million net assets, albeit relying on £160 million intangibles besides £232 million property assets. Even if net assets currently benefit from around £20 million cash remaining from August’s share offer, they are insubstantial.
The stock market justifiably began to write McColl’s off, given that supply chain disruption has happened just at a time when the company must leverage its way into better profits.
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In the short term (though looking back to end-May figures), the group has to support £323 million debt and £187 million trade payables, versus just £30 million trade receivables. In fairness, management had cut trade payables by 17% over 12 months, although it looks as if McColl’s has teetered along, effectively taking credit off suppliers. It’s not clear quite to what extent this involved Morrisons’ exposure, or whether its new owners may insist on better terms. Changes in working capital dynamics have their own effect on profit and loss, which is another material unknown for McColl’s.
Against such a balance sheet, bankers have agreed to defer a financial covenant test to end-December, allowing additional time to reach agreement on managing this in the financial year ahead, and also when the debt matures in February 2024.
The interim income statement showed debt generating £8.4 million net finance costs, which overwhelmed the £6.3 million operating profit. A £2.9 million adjusted net loss resulted, although the reported interim loss was £6.3 million.
I doubt whether the apparent consensus forecast for a slight loss in the latest financial year reflects the 17 November warning. The hope is for around £5 million net profit in 2022, and earnings per share (EPS) of 0.7p – in other words, a “fair enough” forward price/earnings (PE) of 17x for the time being.
McColl's Retail Group - financial summary
|Turnover (£ million)||932||950||1,149||1,242||1,219||1,258|
|Operating margin (%)||2.5||2.1||2.1||1.3||-7.4||1.0|
|Operating profit (£m)||23.6||20.4||23.5||15.9||-90.4||12.3|
|Net profit (£m)||16.1||13.9||14.2||6.9||-95.9||-2.7|
|EPS - reported (p)||15.2||12.7||12.1||5.9||-82.2||-2.3|
|EPS - normalised (p)||15.2||14.5||17.7||9.1||11.5||4.0|
|Price/earnings ratio (x)||3.0|
|Operating cashflow/share (p)||41.0||19.7||46.2||52.9||17.1||42.0|
|Capital expenditure/share (p)||16.6||14.5||21.9||16.8||12.4||14.8|
|Free cashflow/share (p)||24.4||5.2||24.4||36.1||4.8||27.2|
|Dividends per share (p)||10.1||10.1||10.2||4.0||1.3||0.0|
|Covered by earnings (x)||1.5||1.3||1.2||1.5||-64.1||0.0|
|Net debt (£m)||31.6||37.0||142||98.6||94.1||282|
|Net assets (£m)||126||141||146||142||38.7||19.9|
|Net assets per share (p)||119||120||125||121||33.1||17.0|
Source: historic company REFS and company accounts
In the classic ‘penny stock punt’ category
Sentiment is liable to waver between fear of an over-indebted, low-margin operator under the cosh of banks, and greed - the potential for a turnaround in a business supplying essential needs and tied to a big food retailer.
The odds of a medium-term tipping point are thus intriguing, with Covid also a dynamic during this key period. Renewed fears of the virus over winter could support more local shopping at the expense of pubs, cafes and restaurants.
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Be aware that if McColl’s cannot sustain its liabilities sufficiently to satisfy its bankers, then Morrisons could become predator instead of ally (to the sense of McColl’s as an ongoing independent business). In such a scenario, and if the stock remained listed, any offer would be unlikely to be at a premium to 12p.
But even if a worst-case scenario came about, if McColl’s does a good job in its 8 December update the stock can rise modestly. Management stands a fair chance of “making its own luck” thereafter. As an initial modest gamble, potentially to average in: Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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