Market Report: Morrisons stands firm on margins story

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The Independent Online

WM Morrison Supermarkets was in focus last night, thanks to Bank of America-Merrill Lynch, which issued a "buy" note, highlighting the potential for improvements in the group's margins.

The broker argued that while the rate of growth in sector sales was likely to slow in the second half as the weather normalises and inflation ebbs, fears of a collapse in trading were "overdone", owing to the likely compensatory effects of more stable economic conditions. Morrisons stands out as, beside the sales story, the market seems to be overlooking the "margin improvement story", Merrill said, calling this a "key area of misunderstanding".

Factors such as the group's underlying earnings margins, which are relatively low, like-for-like comparatives, which are easing, its vertically integrated fresh food model, which should have benefited more than the competition from the heatwave, and the fact that in a deflationary petrol price environment it sells more petrol as a ratio to sales, should allow the group to build its margins in 2009/10, the broker explained.

"We believe that the margin story on Morrison is very much intact and is likely to not only come quicker than the market expects but also to continue for longer as the group gains the confidence to accelerate growth and take out or dilute costs further," Merrill said, moving its recommendation to "buy", which helped the stock to close at 243p, up 2.75p, last night.

Overall, it was another quiet day on the markets, with both the FTSE 100, down 7.91 points at 4,187, and the FTSE 250, down 1.84 points at 7,318.51, closing broadly flat.

Parts of the mining sector, including Kazakhmys, which gained 10.5p to 602p, and Vedanta Resources, which was 22p stronger at 1,322p, firmed up as investors bought in on recent weakness. There was also a revival of bid talk, with vague rumours – played down by traders – suggesting that Xstrata, up 4p at 610p, may team up with Vale, the Brazilian mining group, to mount an offer for Anglo American, down 1p at 1,627p.

Elsewhere, over in the banking sector, Lloyds was broadly flat at 66p, down 0.1p, while Barclays gained 3.25p to 296p as traders looked forward to the White Paper on banking reform, which is due to be released today.

Among insurance issues, Aviva was 6.25p weaker at 331p, as Cheuvreux switched its stance on the stock to "underperform" from "outperform". Nomura, which reiterated its "buy" stance, was more positive, saying that its cash-flow analysts suggested that the company "only needs to reduce its dividend by 25 per cent to be cash covered in 2010".

"Although we believe that the 2009 dividend will not be cash covered owing to a combination of lower life asset values and higher staff pension and interest costs, we do not think this poses a threat to solvency and our analysis suggests that if markets are more stable from 2010 onwards then Aviva will have little problem funding its dividend," the broker said, adding that "a 25 per cent dividend reduction this year would still leave it with a 7 per cent dividend yield", which would be among the highest in the sector.

Nomura also weighed in on the oil exploration & production sector, initiating coverage on Tullow Oil, which was 3.5p ahead at 890.5p, and on FTSE 250-listed Premier Oil, down 4p at 1,053p, with "buy" ratings. The broker was less keen on Cairn Energy, down 28p at 2,178p, and FTSE 250-listed Dana Petroleum, down 8p at 1322p, both of whom were initiated with "reduce" ratings.

"We think [second-half] performance will be less about the oil price and more about drilling activity that is beginning to pick up; our two buy rated names, Tullow and Premier, offer good risk-adjusted exposure to this theme," Nomura said, adopting a "neutral" sector view.

On the second tier, the housing sector was back in focus, as the markets took an upbeat update from Persimmon, up 7.4 per cent or 27p at 390.25p, as confirmation that the slump was indeed moderating.

Collins Stewart, which maintains a "hold" recommendation on Persimmon, agreed, as did Numis, which said that the statement "confirms that the pick-up in housing demand continues to feed through".

The uptick in sentiment boosted the likes of Barratt Developments, which climbed to 160p, up more than 7.2 per cent or 10.7p, Bellway, up 4 per cent or 25p at 652p, and Bovis Homes, which strengthened to 406.5p, up almost 4.3 per cent or 16.7p.

Further afield, Marston's, which went ex-rights, held up well, gaining 1.14p to 93p. GKN, on the other hand, eased to 80.75p, down 2.77p, as it began ex-rights trading.

Among smaller companies, International Personal Finance advanced to 70.75p, 4 per cent or 2.75p stronger, thanks to Goldman Sachs, which initiated coverage on the stock with a "buy" rating and a 105p target price, saying that while it expected an increase in loan impairments both this year and the next, the current valuation did not reflect "the company's ability to tighten underwriting standards quickly".

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