Is private equity tearing the soul out of Morrisons supermarket?

The UK chain’s thrifty founding family would never have run it this way. Now, with high debts and falling profits, signs look grim

‘We all say he would be turning in his grave. It is not what it was,” says one former member of staff outside the Girlington branch of Morrisons in Bradford.

On the streets of the West Yorkshire city that Sir Ken Morrison helped put on the map, the mood surrounding Britain’s fifth-biggest supermarket chain is decidedly glum.

The former employee is far from alone in shuddering at the thought of what Morrison, who created a national chain from his dad’s grocery shop, would make of its current state.

Sixteen months on from a feverish bidding battle that ended with the giant US private equity firm Clayton, Dubilier & Rice (CD&R) taking it over for £7bn, the 124-year-old chain has fallen into a hole that just keeps getting deeper.

While shoppers grumble about gaps on shelves, prices that keep rising, a less-rewarding loyalty scheme, fewer staff, increasingly tatty stores and more of the dreaded self-checkouts, the financial players that supported the top-of-the-market takeover are also getting cold feet. Spooked by the chain’s haemorrhaging of market share and rising interest rates, the banks that supported the deal to buy Morrisons have just offloaded €500m of debt at a steep discount, making a loss on their investment.

What happens next to Morrisons matters hugely for its 110,000 staff, its army of suppliers and the communities that rely on it across the UK. Rising interest rates and departing customers heighten the risk that its private equity owners – which piled it high with debt via the takeover – will resort to tried-and-tested tactics of asset-stripping and cost-cutting to scrape together the overly optimistic returns they promised their backers 16 months ago. Troubling signs of that are already starting to emerge.

Rumour has it that Morrison, who was knighted in 2000, was once spotted rooting through the bins behind a store to check whether fresh food was being wasted. When the Yorkshireman rolled out new shops, he prided himself on funding them with profit rather than debt.

Even in his final chairman’s report before retiring in 2008, Morrison stuck to the same thrifty theme. Net debt had fallen by more than £200m in a year to £543m, he said, while profits had soared to £612m. Morrisons would “continue to prosper as long as it remains true to its founding principles”.

Those principles have gradually been eroded in the intervening 15 years: debt has gone north and profits south. That recent deal by banks to offload a portion of its debt emerged just as the Moody’s credit rating agency warned that the outlook for Morrisons’ ability to repay its £7.5bn of gross debt, including lease obligations, had shifted to negative from stable.

The group’s debt rating was knocked even further into junk territory – a level where investors are warned of high risk that it will default on some of its obligations. Moody’s pointed out that Morrisons’ profits before interest and tax would cover only half of its interest bill of £375m.

The downgrade reflected a 15% slide in underlying profits to £828m in the year ending 30 October, as sales at established stores decreased by 4.2%. Once exceptional items were included, the chain slumped to a pre-tax loss of £33m.

The fall in revenues came despite the fact consumers were paying more on average for each item, with annual food inflation across the sector hitting 13.3% last month, according to the British Retail Consortium – implying an even steeper drop in sales volumes.

It is tough times for Morrisons, which began selling eggs and butter on a market stall in Bradford in 1899 and now employs more than 110,000 staff in 500 supermarkets, over 1,000 McColl’s convenience stores and 19 food processing sites.

Morrison took over his father’s market business in 1952 and opened his first shop in 1958, gradually expanding until the group went national through the acquisition of the Safeway chain in 2004.

Morrisons’ net debt obligations were £3.2bn before the CD&R takeover, compared with almost £6bn now, or the £7.5bn when other obligations are included.

Morrisons’ new backers, who were advised by the former Tesco boss Sir Terry Leahy, have found themselves caught between surging interest rates, falling property values, cost inflation, a rising wage cycle and a squeeze on consumer spending.

With much of its debt tied to rising interest rates, Morrisons’ annual interest bill has shot up by £100m in the past year to an expected £400m this year, according to Moody’s, reducing its ability to compete and making it more financially fragile.

One senior retailer says supermarkets may be “cash-generating machines” but their tight profit margins mean “you don’t have a huge amount of room for error”. He says that once things start to go wrong, a business can enter a “doom loop” which is likely to end in the debt owners having to write off some of what’s owed, or assets being sold to reduce the debt load. As one former senior member of the Morrisons team puts it: “[CD&R] paid too much and now they have to claw that back.”

The high levels of debt have rung warning bells for industry watchers, who have seen a series of retailers struggle under private equity ownership.

Debenhams, which collapsed with the closure of more than 120 department stores in 2020, is seen as a prime example of a retailer hobbled by debts from its time under private equity ownership. It was owned by a trio of private equity funds, CVC, TPG and Merrill Lynch, before being sold to stock market investors.

Before flipping it back on to the market in 2006, they cashed in the department store chain’s prized freeholds, signing it up to leases spanning decades. Those leases became an albatross around its neck. Other private equity casualties on the high street have included Toys R Us, Maplin and HMV.

Nadine Houghton, the national officer of the GMB union, says: “We see too many UK high street institutions being preyed upon by highly debt-leveraged capital.

“From Morrisons to Asda, these deals risk hard-working people’s jobs. The government and the [Competition and Markets Authority] have a responsibility to perform proper due diligence and stop private equity bandits playing fast and loose with the lives of workers to make a quick buck.”

Asda was bought by the billionaire Issa brothers and the private equity firm TDR Capital in 2020 from Walmart in a deal that valued the supermarket chain, also based in Yorkshire, at £6.8bn.

David Potts, chief executive of Morrisons, recently said the business was “combining well with CD&R to be more effective”, and was on track to increase profits in 2023 after “a year of transition”. He declined to be interviewed for this article.

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Morrisons is a long way from collapse. It has now hedged or fixed interest rates on about 75% of its debts and will not have to refinance any significant slug of its debt until 2025, but experts say supermarkets are particularly ill-suited to private equity ownership.

Nick Hood, an expert on retail restructuring at Opus Business Advisory Group, says: “If you put a low-margin investment-hungry business into the hands of investors looking for above-average returns and give it a huge debt burden, it is not a merger made in heaven. If you look at Morrisons’ debt burden and add in a sharp rise in interest rates, you are looking for trouble.”

When CD&R won the auction for Morrisons with a bid that was 60% higher than its stock market price, it promised that it had no plans to sell off a significant chunk of its valuable store estate to raise cash.

Those promises – which were not legally binding – are starting to look hollow. Retail experts say Morrisons is looking to raise up to £1bn from asset sales to reduce its debts and fund investment.

Property industry insiders say that Morrisons, which owns the freehold on 85% of its properties, is marketing at least five stores which are expected to raise about £110m via a sale and leaseback, with a second parcel of five or six ready to go.

Those deals come after Morrisons raised £220m via a sale and leaseback of warehouses. That deal apparently fell well short of CD&R’s hopes of raising as much as £750m from selling distribution assets, as they were pitched into a sluggish property market as a result of the retreat of online retail after the pandemic. While sale and leasebacks release cash up front, they saddle a company with a permanently higher rent bill.

The senior industry insider says CD&R may look to sell off Morrisons’ prized manufacturing arm – which is unique among big UK supermarkets and includes abattoirs, vegetable packing houses and fish processing plants – to raise further cash and make the business more efficient. Such a move would mean a complete change of course for the company, which has built its model on a vertically integrated supply chain.

Morrisons’ pension fund trustees also recently took out an insurance policy on a tranche of its main pension scheme which limited its liabilities and potentially means a modest return of assets to the company.

With trading under pressure, the group is thought to be seeking a replacement for Potts, who has been in post for eight years and is now 65. But runners and riders – thought to include Tesco’s UK boss Jason Tarry, Asda’s former boss Roger Burnley and former Aldi boss Matthew Barnes – will have reservations about taking on such a challenge.

As the war in Ukraine and political problems in the UK helped push up costs, Morrisons’ prices rose well ahead of rivals’ between July and October last year, according to data from market research firm Nielsen. Potts said the group’s vertically integrated model – it packs and processes a large proportion of its fresh meat and produce itself – means inflation hit it first.

Shoppers are voting with their feet. “Since they sold [the business], it’s expensive and there’s hardly anything there,” says Dawn Overton, 49, who has shopped at the Bradford store, a few metres from the first Morrisons, for many years. “It’s not good. The prices are ridiculously high. I have started to go to B&M first.”

Overton’s comment points to the reason Aldi and Lidl grabbed more market share from Morrisons last year. As the German-owned discounters open dozens more stores a year across the UK, the Yorkshire-based retailer lost its spot as the UK’s fourth-largest grocer to Aldi and is expected to be overtaken by Lidl within a year.

Asda, its rival, which has a strong influence on Morrisons as the two chains are both focused on northern England and have many sites near each other, has got its act together – launching a new cut-price range, opening convenience stores and brightening its supermarkets with concessions from a range of lively brands, including the food chain Leon.

At the same time, Morrisons’ plans have been held back. Competition watchdog investigations into its acquisition of McColl’s convenience stores and CD&R’s combined ownership of its Motor Fuel Group and Morrisons’ petrol stations have reduced options for cost-cutting and held up plans to expand convenience stores by converting McColl’s outlets into Morrisons Daily shops.

Morrisons has begun to fight back with a wave of price cuts and promotional gambits, helping sales performance to improve since December. It has just announced £25m of price reductions, taking the total of such cuts to £148m in the past six months.

But inside the Bradford store on a sunny February weekday, it is clear more investment is needed. There is a notable absence of staff on the famed fresh food counters. A solitary member of staff oversees the deli, pizza and salad bars, while the meat and fish counters are unstaffed. The “Market Street” counters, with expert butchers, bakers and fishmongers, have been a core part of Morrisons since the 1980s. They give it a point of difference from its rivals – most of whom ditched these to save costs.

Shoppers confirm this is a regular issue: “They are losing all the staff. Workers who have been there for years are saying they can’t face this. They are not happy at all with the way [the takeover] has worked,” says one shopper who is a retired employee.

Morrisons says it is now increasing staff hours in stores and is currently locked in talks with unions over this year’s pay deal. But as it stands, the retailer will be the bottom of the league on hourly pay at £10.20 for shop workers from April, after Asda handed its shop staff a 10% pay rise to £11 an hour from £10.10.

And in a market where shoppers are ever more price sensitive, notable numbers of shoppers in its West Yorkshire heartland admit that they now mostly visit Aldi, Lidl or Home Bargains for their weekly shop.

“The price of everything is going up. I go to Iceland and Home Bargains – pasta and cereal is cheaper there,” says Jessica Parker, 27, a shopper at Morrisons’ flagship Kirkstall outlet in Leeds.