Morrisons | Annual Report and Financial Statements 2010

Summary of results

The Operational review contains information about the Group's financial performance for the year, in particular turnover growth, like-for-like sales growth and operating profit. The review also contains information on selling space increases and our future space expansion programme.

The Group uses underlying profit as its measure to assess normal underlying business performance and trends. Earnings are adjusted to remove volatile or one-off costs and credits. A reconciliation of underlying profit is provided in note 1 of the Group financial statements.

Balance Sheet

As part of the IASB's Annual Improvements 2009, the Group has adopted an amendment to IAS 17 Leases. The amendment removed the automatic classification that land leases are operating leases and requires a review of all land leases held, the conclusion being that all long-lease land premiums have been reclassified as finance leases.

The amendment is classified as a change in accounting policy, and therefore the financial statements include a prior year restatement. The adoption has resulted in a) derecognising long lease land premiums; and b) recognising a corresponding increase in the closing net book value of leasehold land and buildings to reflect the carrying value of the leased assets. Therefore, the impact on the balance sheet is reclassification only. The newly classified finance leases are depreciated over the life of the leases, consistent with the annual amortisation charge incurred on the previous lease prepayments. The net effect of the reclassifications has no impact on net profit before tax for the year ended 30 January 2011, or reserves of the comparative periods.

Summary cash flow

The Group's net debt reduced over the period as a result of net cash generation.

Cash generated from operations

Cash generated from operating activities once again improved as a result of strong operating cash flows which increased £127m year-on-year.

Interest and tax

Interest

Net interest paid was £47m, a decrease of £5m from 2010. Interest rates remained low throughout the year reducing both interest paid and interest received year-on-year. Interest paid on bonds dropped £9m following the repayment of €250m Euro bonds in April 2010. Interest was covered 30 times (2010: 19 times). The Company's effective interest cost fell from 4.4% to 4.0% in the year.

Tax

Corporation tax paid in the year was £191m (2010: £209m). This cash outflow represented 50% of the total tax bill for the year to 31 January 2010, and 50% of the tax for the year to 30 January 2011. It included repayments received for prior years.

The effective tax rate for the year was 27.7% which is slightly below the prevailing corporation tax rate of 28%. The difference is due to the change in corporation tax rate from 28% to 27% which reduced deferred tax liabilities by £20m, offset by non-qualifying depreciation and expenses for which the Group is unable to obtain a tax deduction. The effect on deferred tax also resulted in a reduction of our effective tax rate of 30.3% last year to 27.7%.

The principal objective of the in-house tax department continues to be to pay the appropriate level of tax at the right time. We actively engage with the UK tax authorities, and aim to be transparent in all our activities. The Group is predominantly UK-based, operates a simple business model, and has not engaged in sophisticated tax planning structures.

Capital expenditure

Capital expenditure during the period was £592m. We continue to invest in growing our estate, strengthening our supply chain and replacing our IT systems, supporting our strategic positioning of investing for long term growth. Overall capital expenditure was lower than originally planned due to tight cost controls and the deferment of the start of the development of our new regional distribution centre at Bridgwater.

Stores and business capital expenditure

We opened 15 new stores including one replacement store, extended 15 stores and refurbished a further 12 stores in the period. Further investments were made strengthening our retail estate and supply chain.

New selling space increased 3% in the year.

*net of replacements

IT systems replaced

As expected capital expenditure on the replacement of our IT infrastructure accelerated and we invested £92m during the year.

Acquisitions

In the first half of the financial year, the Group invested further to strengthen our manufacturing capabilities in order to improve our offering to our customers. The investments made were in a prepared vegetable facility and a cooked meat production plant. Both acquisitions are treated as 100% subsidiaries for accounting purposes, creating £7m of goodwill. Further information can be found in note 27 of the Group financial statements. Cash outflow and acquired debt was £3m and £4m respectively, with a deferred payment in 2013 of up to £13m.

In January 2011, we announced it had entered into a conditional agreement to purchase 16 Netto stores from ASDA. At the year end, no formal contract had been agreed and no costs have been accrued in relation to this acquisition. The stores will add 120,000 square feet of selling space at an acquisition price of £28m and with further conversion costs of approximately £20m.

Net debt

At the end of the financial year, net debt was £817m, a decrease of £107m from the prior year end. The decrease was due to a combination of increased cash from operating activities and a reduced level of capital expenditure compared to the previous year. In 2009/10, the Group had a higher level of capital expenditure due to the acquisition of 38 stores from the Co-op for £325m and the development of a new regional distribution centre at Sittingbourne.

At the balance sheet date, we had utilised £475m of our revolving credit facilities, with a further £625m remaining undrawn. On 4 March 2011 we completed a new revolving credit facility at competitively priced margins with our banks, providing £1,200m of committed facilities for 5 years.

Gearing

Our gearing ratio was 15% (2010: 19%) and is well below the sector average, demonstrating our strong balance sheet. Our credit rating (provided by Moody's) remains strong at A3, and we continue to be one of only three European retailers to have this rating.

Pensions

The Group sponsors two defined benefit pension arrangements and both of these pension schemes are managed externally to, and independently of, the Group's operations. Our approach to valuing our defined benefit pension obligations remains prudent.

At 30 January 2011, the schemes had a surplus of £38m. The improvement, from the deficit of £17m at 31 January 2010, is summarised in the table below.

IAS19 Employee benefits requires the Group to assess the liabilities with reference to the market conditions at the balance sheet date and the Directors' best estimate of the experience expected from the schemes.

The movement in the year has been influenced by three factors:

• changes in assumptions due to changes in market conditions;
• an update of information on the schemes following the triennial valuation; and
• a change in the way future pension increases are measured.

Scheme assets performed better than assumed returns, however, the liabilities increased by £191m due to a combination of financial and demographic changes in assumptions. Over the year market conditions deteriorated, in particular for Corporate bond yield returns while inflationary expectations rose. A review of longevity was made as part of the triennial valuation review as mentioned below.

The results of the triennial valuation review are based on the latest information on scheme members. This update of the membership status resulted in an improvement to the funding position of £91m.

Further to the above, the schemes value improved due to a one-off increase as a result of changing the way future pension increases (inflation) are measured. In 2010 the UK Government changed the way in which pension increases will be measured in future, by changing the benchmark index to the Consumer Price Index rather than the Retail Price Index. Both the Trustees and the Company consulted legal and actuarial advisors to assess the impact of this change on the two schemes and this resulted in the liabilities of the schemes being reduced by £72m.

The triennial actuarial valuations of the schemes were completed in April 2010 and funding and investment strategy agreed between the Group and the Trustees of the schemes. There was a small combined deficit at this valuation date and the Group has entered into an agreement with the Trustees to pay £30m per annum to meet the cost of pension benefits being built up by the current employees. It is assumed that the small deficit in the funds will be eliminated by the schemes' expected superior investment returns. In line with our prudent approach, we have used the most up-to-date mortality tables, which provide the average life expectancy of members in the UK, this being the latest advice from the Pension Regulator.

Returns to shareholders

Dividends

The Board has recommended a final dividend of 8.37 pence per share, making the total dividend for the year 9.60 pence per share, an increase of 17% year-on-year. Payment of the final dividend will be made on 15 June 2011 to shareholders on the register on 13 May 2011.

Dividend cover reduced to 2.4 times, in line with the European food retail sector average. We have reviewed our dividend policy and we are committing to a three year annual dividend growth of at least 10% starting in the new financial year. We will also rebalance the split between interim and final dividend payments to be c30:70 in the future.

Shareholder investment and returns

Total shareholder return measures the value of £100 invested in Morrisons compared to the FTSE100 movement. Since 29 January 2006, Morrisons shareholder return has risen 56% compared to a rise in the same period of only 24% and 49% in the FTSE100 and FTSE Food and Drugs sector respectively.

An equity retirement plan was approved by the Board for announcement on 10 March 2011 to purchase in the market £1 billion of ordinary shares over the coming two years, for subsequent cancellation.

Investments since year end

Subsequent to the year end, the Group announced it would acquire the trade and assets of kiddicare.com, a multi channel online retailer for £70m. The acquisition was completed on 28 February 2011.

Additionally, on 9 March 2011 we invested £32m in a c10% stake of FreshDirect, an internet grocer in the US.

Key judgements and assumptions

Judgements and assumptions made in the financial statements are continually reviewed. Whilst some outcomes have been affected by the volatility in the financial markets, all judgements and assumptions in the accounting policies remain consistent with previous years. Consideration of impairment to the carrying values of assets has been made and we concluded that the individual carrying values of stores and other operating assets are supportable either by value in use or market values. The impact of the current economic conditions on the assessment of going concern has been considered in the general information section of the Directors' report.