Interactive Investor

Stockwatch: could this stock double with Morrisons’ tie-up?

Managing debt will be an issue, but McColl’s could persevere.

26th March 2021 15:04

Edmond Jackson from interactive investor

Managing debt will be an issue, but McColl’s could persevere.

A year ago, I examined small-cap convenience stores group McColl's Retail Group (LSE:MCLS) after its chairman had bought £18,750 worth of shares at 25p, sending the price up to 36p.

Its market cap was only just over the £27 million cash on its balance sheet, but it also had £94 million net debt also within net assets, an eye-popping £216 million trade payables versus £39 million trade receivables.

McColl’s appeared highly speculative, although in the early stage of the pandemic, and knowing nothing of the extent of stimulus about to be released, ‘local shopping’ was a relevant defensive theme. 

Relationship with Morrisons is key

In particular, I was intrigued at an evolving relationship with supermarket chain Morrisons (LSE:MRW). This effectively uses McColl’s to evolve a Morrisons Daily fascia, quite like Sainsbury and Tesco have developed small stores to capitalise on local demand.

Supported also by Morrisons’ wholesale side, this appeared potentially able to underwrite McColl’s in the long run. The deeper Morrisons got involved, the more motivated it would become to see McColl’s prosper.  

I thought that if the board could at least get debt on a managed path of reduction, that could avoid shareholders being wiped out in a worst-case scenario of a ‘company voluntary arrangement’ with creditors.

With the pandemic upon us, it appeared far less likely that banks – themselves helped with monetary stimulus – would anyway pull the plug on local retail as a vital community service. Half of McColl’s customers were reckoned to live within 400 metres of its stores.  

The medium-term strategic aim was to manage the estate down from around 1,400 stores to 1,100, possibly with new site acquisitions helping the goal for a wider product range. 

A sense of déjà vu as regards Budgens 

In marketing terms at least I continue to sense a parallel with a vanished name on the high street. From the mid-1990s Budgens underwent a not-dissimilar marketing revamp, although was seen as a rather boring small cap until acquired in June 2002 by the Irish Musgrave Group. Its estate was subsequently churned – some stores sold to independent retailers, others acquired from the Co-op – and in May 2015, Budgens was sold for £40 million to Booker Group.  

By March 2018 however, Booker had itself been acquired by Tesco hence over some 20 years the chain of Budgens shops has effectively become what we now see as Tesco Express.  

Reading across to Morrison’s operating review in its 11 March preliminary results, the company says: “For wholesale, our supply partnership with McColl’s is scaling up very quickly, and there is significant future potential for the Morrisons Daily fascia and format…”  

My sense is the major supermarkets now have a very hard challenge to expand revenues given the difficulty to obtain sites – if consumer demand even exists for any more large-format stores. Latest surveys suggest consumers will continue to shop local even as the pandemic eases.   

Stock behaviour suggests debt continues to weigh 

By early last June, McColl’s was testing a mid-50p price range. Yet, despite the August interims showing an 8.3% rise in like-for-like sales, margins had slightly eased as shoppers prioritised essential items.

The stock went into a steady downtrend that did not bottom until 20p last autumn. Despite a rebound over 30p amid November’s enthusiasm for vaccines, the price was back to 24p this last February. There was then a spike to 37p in early March and another drift back. After latest prelims to 29 November 2020, the price is currently 33p. 

Such a chart suggests that each time in the last year, enthusiasm has gathered over McColl’s long-term marketing prize, it is knocked back by shareholders exiting – probably because they are wary of the debt burden. 

Cash flow helping pay debt and lease liabilities down 

Mind how the 29 November balance sheet lumps lease liabilities within £273 million of ‘loans and borrowings’, however note 12 explains this as £194 million lease liabilities post IFRS 16. On a pre-IFRS 16 basis, net debt has eased 5% below £90 million.  

Cash is down 37% to £23 million, despite the cash flow statement showing a 145% jump in net cash from operations to £49 million. This was due to £18 million going out to repay bank debt and £23 million reducing lease liabilities.  

Bank facilities have been extended to February 2024, with more flexible headroom. 

Within £20 million net assets there were £160 million intangibles Note 9 of the interim results clarifies this as goodwill which incurred a £99 million impairment charge during the year, substantially explaining the reduction from £254 million intangibles. 

Furthermore, a gross imbalance of trade payables versus trade receivables persists, with payables stuck on £215 million versus receivables of £42 million. 

It therefore remains a poor balance sheet. You would certainly avoid if long-term interest rates looked set to rise. The income statement shows net finance costs swiping 94% of £18.7 million operating profit. 

McColl's needs to raise revenue at better margins and cut costs to leverage shareholder value. Yet, if the marketing mix continues to evolve and a habit of buying local sticks, the chances rise of this retailer becoming value-accretive.  

Due to success with the Morrisons Daily format, the partnership has been extended to January 2027, offering both security of groceries supply and “an important strategic opportunity” to convert 300 stores over the next three years. 

McColl's Retail Group - financial summary
Year end 24 Nov

  2014 2015 2016 2017 2018 2019 2020
Turnover (£ million) 922 932 950 1,149 1,242 1,219 1,258
Operating margin (%) 2.0 2.5 2.1 2.0 1.3 -7.4 1.0
Operating profit (£m) 18.9 23.6 20.4 23.5 15.9 -90.4 12.3
Net profit (£m) 9.9 16.1 13.9 14.2 6.9 -95.9 -2.7
EPS - reported (p) 10.1 15.4 12.8 12.3 5.9 -83.3 -2.3
EPS - normalised (p) 21.3 15.4 14.7 17.9 9.2 5.6 0.6
Price/earnings ratio (x)             55.0
Operating cashflow/share (p) 35.4 41.6 20.0 46.9 53.6 17.4 42.5
Capital expenditure/share (p) 15.5 16.8 14.7 22.2 17.1 12.5 15.0
Free cashflow/share (p) 19.9 24.8 5.3 24.7 36.6 4.8 27.5
Dividends per share (p) 8.5 10.2 10.2 10.3 4.0 1.3 0.0
Covered by earnings (x) 1.2 1.5 1.3 1.2 1.5 -64.1 0.0
Cash (£m) 11.4 14.5 3.8 14.3 28.5 37.0 23.2
Net debt (£m) 37.4 31.6 37.0 142 98.6 94.1 282
Net assets (£m) 117 126 141 146 142 38.7 19.9
Net assets per share (p) 112 120 122 127 123 33.6 17.3

Source: historic company REFS and company accounts

Can the margin mix adjust back upwards, as hoped? 

2020 saw like-for-like sales growth of 1% driven by groceries and beer/wine/spirits. Obviously, alcohol’s contribution could ease with the re-opening of pubs. Yet management hopes that as lockdown restrictions ease, the sales hence margin mix will normalise with greater purchases of impulse products.  

Over 15 weeks to 14 March, like-for-like sales growth has been 8.8% albeit with the trend towards lower-margin products continuing “as a result of the third national lockdown”.  

In such context I note a partnership also with Uber Eats (switched from Deliveroo) across 400 stores from this March (up from 135) enabling groceries delivery “in as little as under 30 minutes”. Time will tell at what margin for bringing in such partners.    

It would have helped to see clarified in the accounts what extent (or not) of government support such as business rates relief had been involved in achieving the 2020 outcome. This is not evident. Moreover, the various details of the going concern statement make no mention of it - or furlough – as necessary for viability.  

Potential to at least double on a two-year view 

Not to imply recovery potential back near 300p a share, but if the partnership with Morrisons leverages marketing success and debt can continue managed down then a net profit of just £10 million would imply earnings per share near 9p, hence a forward price-to-earnings ratio of 3.5x. For those who recognise a highly speculative tag, I retain my stance: ‘buy’.     

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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