“I like being forced to think about things in a different way,” the humourist Clive Anderson once observed – very possibly in relation to the part of the improvisational comedy television show ‘Whose line is it anyway?’ he used to host in the 1990s where panellists were challenged to use a household implement in a variety of unusual, creative and, ideally, humorous ways.
This sort of approach may work well enough in the world of comedy but, here on The Value Perspective, we tend to be a little wary when anyone starts trying to persuade us that – if only we were to think about it in a different way – an investment or asset could have an alternative valuation from the one we have reached.
Occasionally, however, we are willing to let our imaginations off the leash and recently found ourselves doing just that in relation to supermarket chain Morrisons. What initially inspired us to do so was the decision by Baupost Group – the hedge fund founded by Seth Klarman, one of our favourite investors – to buy a 51% stake in Bakkavor.
If that name rings bells, it may be because Bakkavor was the Iceland-based food manufacturer that went on quite a buying spree during the boom times the island enjoyed in the middle of the last decade. Bakkavor has still not managed to pay down all the debt it took on during that period and one might speculate the fact this debt pays upwards of 8% is at least part of the reason for Baupost’s interest.
Baupost reportedly paid £163m for its stake, which would value Bakkavor at £325m. Once net debt is added into the mix, the whole of the company is valued at just shy of £800m – or 11.7x last year’s earnings before interest and tax (EBIT). This is what set us thinking about Morrisons because one thing that sets it apart from its UK rivals is it has its own food manufacturing company, Farmer’s Boy.
If you look at Morrisons’ most recent accounts, you will see that Farmer’s Boy made £80m in EBIT and, if you put that on the same multiple Baupost paid for its Bakkavor stake, the business would be worth £700m. That equates to roughly a fifth of Morrisons’ current market capitalisation – for a part of the company that much of the market barely seems to have noticed even exists.
Mind you, investors are likely to have started paying a bit more attention since 29 February as that was the day Amazon announced it would be using Morrisons to grow its online food produce business in the UK. Much of the detail of this deal has yet to emerge but it would certainly suggest there could be some value in this hitherto overlooked area of Morrisons’ business.
While we are thinking differently, we should also touch on Morrisons’ land. For a second thing that sets the company apart from its UK rivals is that it owns 90% of the land it uses – by contrast, the likes of Sainsbury and Tesco tend to lease a far higher proportion. When this attracted the attention of Elliott Advisors this time last year, the hedge fund put a value on Morrisons’ land of some £9bn.
Supermarket property has probably fallen in value since – in fact, Morrisons has written down some of its own land over the last year – and yet it seems unlikely to have fallen sufficiently to justify the £6.7bn valuation the market is currently ascribing to the whole business. In fact, going solely by housebuilder Taylor Wimpey’s valuation of 2x its asset base, Morrisons stands on a 20% discount.
Clearly there are plenty of reasons why Morrisons is so cheaply valued – the short version being ‘Aldi and Lidl’ – and yet this is a business that is generating cash to pay down it debt while also improving its operational metrics. Furthermore, if we were inclined to play the game from ‘Whose line is it anyway?’, the fact the company’s intrinsic value away from its supermarket assets is significantly above current market valuations could be seen as offering further comfort to long-term investors.