The question that any investor should ask before buying a share in a British food retailer is: “Should I invest in this industry?” It is an important question because the food retail sector may be large and competitive, but it is hardly a licence to print money.
The Big Four grocers appear to have fairly juicy profits but these are down to large sales bases. Last year Tesco generated a pre-tax profit of £1.3 billion, but off revenue of £57.5 billion. Wm Morrison’s profits came in at £380million, off sales of £17.3 billion. And, until recently, these profits were in decline too. About eight years ago Tesco and Morrisons were reporting far higher underlying profits: £3.4 billion and £760 million respectively.
The situation is similar at Asda and J Sainsbury, Britain’s third and second largest grocers. They are both making less profit than a decade ago, which probably helps to explain the motivation for the duo’s decision to try to merge their businesses.
The Big Four are operating in an industry that can barely cover its cost of capital, generating paltry net margins for the industry of about 2.5p in the pound. It is a fiercely competitive market and things are only going to get harder. Costs are still rising, volumes are largely flat, there is still too much grocery retail space in Britain and discounters continue to gain market share.
This structural change is driving the recent wave of consolidation. Tesco, Britain’s largest grocer, kicked things off by merging with Booker, the cash and carry group, and now Sainsbury’s is starting a potentially long process to merge with Asda, owned by Walmart. There is, no doubt, more consolidation to come.
If the “Sasda” combination succeeds, the enlarged group will create a grocery giant with revenues of £51 billion and 330,000 employees. It will also have a market share of 31.4 per cent, according to the most recent Kantar Worldpanel figures, overtaking Tesco’s near 28 per cent. Morrisons will have about 11 per cent.
The Sasda tie-up has the potential to put more pressure on margins; bosses have pledged to reduce prices on some items by about 10 per cent.
In the short term, the proposed merger does not actually change the situation in Britain’s food sector inordinately. Sainsbury’s and Asda will continue to operate separately while the Competition and Markets Authority assesses, a process which could take up to 18 months.
Tesco and Morrisons, as well as other rivals such as Aldi and Lidl now also know that they have more than a year to sharpen their focus on pricing. As one market expert put it: “You can be sure the likes of Tesco and Morrisons are preparing a welcome party for Sasda”, which could lead to gains for both grocers, whose profits and stock price have been recovering as their turnaround programmes gain ground.
Morrisons might seem the most disadvantaged, being the smallest, but it could benefit by picking up stores that Sainsbury’s and Asda might have to dispose of through the competition process. It also remains differentiated from its rivals as it has a manufacturing and wholesale division. Tesco may become the market’s second largest grocer, but it would be an easier business to run than a dual-brand Sasda. It also still has the benefit of the synergies from its merger with Booker to flow through the business.
For the past two years it is clear that both Tesco and Morrisons’ profits have been improving and there is nothing to suggest that this will change, at least in the short term. For those with an appetite for a sector that will endure a volatile environment for the next few years, these two grocers are worth a punt.
ADVICE Buy
WHY With improving profits and at least a year or more before the Sainsbury-Asda merger happens, there are share price gains to be made
Centamin
Demand for gold has recorded its weakest start to a year for a decade, according to the World Gold Council, which yesterday blamed stagnant prices and higher US interest rates for denting the metal’s appeal.
That gloomy update did little to dispel investor enthusiasm for shares in Centamin. The Egypt-focused FTSE 250 gold miner kept investors smiling with a 71 per cent rise in first-quarter earnings on the back of higher output and improved prices.
For investors looking for exposure to gold without purchasing the metal itself Centamin — whose main asset is the Sukari gold mine in Egypt’s Eastern desert 900km from Cairo — offers some big advantages.
Sukari, which began production in 2009, remains highly cash generative. The group has a strong balance sheet with no debt and cash and liquid assets of $426.5 million at the end of March. That was ahead of a final dividend of $115.2 million, which was paid on April 6. Moreover, its Sukari deposit should be able to maintain production for many years, which is not the case for many miners which struggle to keep ageing projects viable.
Yesterday Centamin’s results were encouraging. The company said that earnings before interest, taxes, depreciation and amortisation (ebitda) rose to $91 million, well above City estimates of $80 million. Gold sales rose 14 per cent to 131,045 ounces, while the average gold price realised rose 9 per cent to $1,328 per ounce.
Last year was the first year of Centamin’s profit-sharing agreement under which the Egyptian government will take 40 per cent of profits for the next three years, rising to 50 per cent after that.
The group is also exploring for new deposits in Ivory Coast and Burkina Faso.
Centamin seems to be recovering from a problem this year with disappointing ore grade from the Sukari mine, which prompted a 19 per cent drop in output in the first quarter.
Yesterday however, the group maintained its full-year production forecast of 580,000 ounces at a cash cost of production of $555 per ounce. At 156¾p, up 1¼p, Centamin’s shares have been more or less stable this year.
ADVICE Buy
WHY Strong balance sheet; no debt and good cashflow
