The turbulent world of retailing is tough enough in its own right for the prospective investor to navigate. The narrower world of supermarkets is even tougher.
Any share owner who decides to take exposure to the retail sector will have to consider at the very least whether to take a position in one of the three big listed grocers: Tesco, Wm Morrison and J Sainsbury. Which, if indeed any, is compelling?
All are members of the FTSE 100, but the biggest by far is Tesco, with a market value not far short of £20 billion. It started life in 1919, when Jack Cohen began selling groceries from a stall in east London. Ten years later he opened his first shop. The modern Tesco operates from more than 6,800 stores worldwide, employs 440,000 staff and last year generated £51 billion of sales and £1.3 billion of pre-tax profits. It owns Tesco Bank, which accounts for just over 10 per cent of its operating profit.
There was a time when the group was the undisputed king of the supermarkets, ratcheting up sales, profits and dividend growth. Not any longer. Like its competitors, it has faced stiff competition from discounting retailers, such as Lidl and Aldi, but also has been losing ground to its big rivals, Morrisons in particular. Its market share has fallen from above 30 per cent to about 27.5 per cent, according to Kantar Worldpanel, the market research group.
Probably the lowest point for Tesco came in September 2014, when it admitted that it had overstated its profits by at least £250 million. It’s close, but Tesco’s shares, off 2½p at 196½p yesterday, are still trading below their level then.
Much of its travails with the alleged wrongdoing are behind it. Last week, a fraud trial against former directors brought to the courts by the Serious Fraud Office collapsed because of insufficient evidence. The group remains bound by a deferred prosecution agreement relating to historic accounting practices that it signed last year. This prevents it from being prosecuted for a pre-specified period subject to conditions, including the payment of a £129 million penalty. The DPA concerns only the potential criminal liability of Tesco Stores Limited and does not address whether any liability attaches to Tesco PLC or any employee or agent of either company.
The company’s most recent results, including a 0.8 per cent rise in underlying group sales during the first half, indicate that the grocer is recoving some of its poise, boosted by the £3.7 billion acquisition of Booker, the wholesaler.
Analysts, including at UBS, have begun to argue that Tesco’s shares have been oversold and offer value, underpinned by the prospect that it may well start to buy back its shares, which would lift their worth.
That’s as may be, but Tesco is not out of the woods yet, its growth options are limited and, while the shares trade at just over 16 times earnings, their yield is a meagre 1.5 per cent.
With a valuation of £6.6 billion, the next largest supermarket is Sainsbury’s, though for how much longer is another question. The first Sainsbury’s store was opened in Holborn, central London, in 1869 by two members of the eponymous family. Now the group operates about 608 supermarkets, a further 815 smaller convenience stores, 844 Argos catalogue shopping outlets and 16 Habitat shops. It also has a banking division, which accounts for a little less than 12 per cent of its operating profits. Group pre-tax profits last year reached £409 million on sales of £28.5 billion.
The world for Sainsbury’s will change overnight if the No 2 grocer is successful in its £7.3 billion campaign to buy Asda, the No 3 player, which is owned by Walmart, of the United States. Success on this front would create a retailer with more than 2,800 stores and 330,000 staff, with an enlarged market share based on Kantar figures of 31.1 per cent, ahead of Tesco.
With the proposed merger working its way through a Competition and Markets Authority investigation that won’t yield an initial view until next year, it’s difficult to judge the outcome. It seems likely that Sainsbury’s would have to sell stores as a condition of securing clearance. Nevertheless, the combined group would be in a strong position to compete aggressively with Tesco and undoubtedly would have profound negotiating power with suppliers. It’s a big bet for Sainsbury’s, which last year called a halt to its attempt to buy the Nisa wholesale group amid concerns about what the regulator might do — and was scooped for the prize by the Co-operative Group.
Sainsbury’s shares, down 5½p at 294½p, trade at more than 22 times earnings, making them more expensive than those of Tesco but with a richer yield, of 3.4 per cent. Uncertainty about the outcome of the Asda plan makes them risky at this stage.
That leaves Morrison’s, unencumbered by attempted acquisitions and most recently delivering quarterly underlying sales growth of 5.6 per cent, slower than its previous three-month period but streets ahead of the opposition.
Britain’s fourth largest supermarket group started as a single stall in Bradford market in 1899 and began its transformation in 1952 when Sir Ken Morrison took control of a small collection of outlets that had been built up by his father. There are now about 491 stores and 105,480 staff at Morrison’s, which last year made pre-tax profits of £380 million on revenues of a little under £17.3 billion. It has a market share of about 10.3 per cent.
Morrison’s still describes itself as being in a turnaround, four years after it was losing customers and sales. What Morrisons has in abundance is options. Its relative size and healthy balance sheet — less than £1 billion of debts and £200 million of cash — mean that it would be well placed to snap up plenty of Asda or Sainsbury’s stores if it chose. It could continue with its impressive organic growth rate and it’s not inconceivable that it could pursue its own transforming merger, with the Co-op, say, or even with Aldi or Lidl.
The retailer’s online offering is in the capable hands of Ocado, its partner, and it has reintroduced the Safeway brand, whose stores always had a strong reputation for value. At 17 times earnings for a yield of about 2.7 per cent, Morrison’s shares, down 4¾p to 223½p, also look to offer the most attractions.
ADVICE Buy Wm Morrison; hold J Sainsbury; avoid Tesco
WHY Morrison’s has room to grow, trading is on a roll and the shares are good value
