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Stable cash flows and high debts can make decent bedfellows. The new private equity owners of UK supermarket chain Asda clearly think so. So must US buyout firms such as Fortress, who are vying to buy Wm Morrison. The question is whether their assumptions can survive in the UK’s cut-throat groceries industry. Sainsbury’s first quarter trading statement suggests the price brawl for customers has not abated.
Private equity buyers need to keep beady eyes on debt interest from their acquisitions. If they lack the fierce focus on market share of the previous owners, that could be good for Sainsbury and Tesco. They have been battling German family-controlled discounters Aldi and Lidl. Now three forms of ownership would be pitted against one another.
Private equity is the ultimate buyer of value stocks. The UK offers bargains. Free cash flow yield for the FTSE 350 is about 14 per cent, according to Bloomberg data.
Supermarkets such as Sainsbury’s generate steady free cash flow, averaging £900m or so over five years. This is despite tough competition. Although like-for-like sales are not available for Aldi or Lidl, both have expanded sales volumes by about 14 per cent since mid-2019.
Family groups worry less about short-term targets than quoted businesses. Through aggressive pricing the German discounters have increased their UK market share to just over 14 per cent.
Sainsbury’s accordingly does not see the buyouts of Asda and Morrisons as bringing much relief. Same-store sales have picked up more than expected, by 1.6 per cent over 2020. But the group continues to “invest in prices”.
Aldi and Lidl do not answer to dividend-hungry fund managers or limited partners eager for a sale to capture profits.
Private equity funds need to consider this. To earn a good return from the eventual resale of supermarket chains, growth plans are needed, or large asset sales. The buyout specialists may hope that land grabs by Aldi and Lidl will slow down. Both have expanded volumes a little faster than store space over two years, but not much more, thinks Barclays.
If the twin threat dissipates, higher valuations could follow. A buyout group that held free cash flow steady could then list Morrisons at an enterprise value of 9.5 times forward ebitda or more.
That is a big “if”. UK-listed companies account in periods of six months. Most buyout groups have a 3-5 year horizon. Some family owners think in terms of generations.
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