UK supermarket stocks have been hazardous terrain for investors in recent years. Tesco’s accounting scandal rocked the sector, sterling’s fall since the Brexit vote has raised costs for retailers and the emergence of discount supermarkets Aldi and Lidl have eaten into British firms’ market share.
The rise of Amazon (AMZN) has also cast a shadow over the high street. With the exception of Tesco (TSCO), many supermarkets were slow to join the ecommerce boom; WM Morrison (MRW) only launched its online grocery offering in 2013.
But there have been signs of improvement in the sector recently, and shares have been resilient this year amid wider market volatility. Marks & Spencer (MKS), Sainsbury’s (SBRY), Morrisons and Tesco are all under new chief executives dedicated to turning their companies around after periods of underperformance.
The UK Government’s “digital services tax” could help domestic retailers claw back some sales from Amazon, although the financial impact is likely to be modest initially. Recent inflation figures suggest that cost pressures in the food sector may be easing, which allows supermarkets to keep price rises restrained.
UK workers' pay packets are also outstripping inflation for the first time in years, which should in theory boost the retail sector. Brexit caution remains, but consumer staples like food should be resilient to an economic shock.
As Britain’s largest listed retailer, Tesco had to reinvent itself after a high-profile accounting scandal in 2014 which involved a criminal investigation by the Serious Fraud Office. The company, which was a common part of FTSE 100 investors’ income portfolio, suspended dividends for four years.
Under a new chief executive and amid a painful restructuring that has cost jobs and seen store closures, dividends resumed this year. Recent half-year results showed a 12% rise in revenue to £31.7 billion and a 2% rise in pre-tax profit to £564 million.
Tesco Upgraded by Analysts
The Tesco share price was boosted by full-year results in April showing a big rise in profit, but the shares are back where they started at the beginning of the year and have not yet recovered the levels above 300p seen before the accounting problems came to light in 2014. Morningstar analysts recently raised their fair value estimate for Tesco to 253p, with earnings enhanced by the acquisition of wholesaler Booker.
Widely held FTSE 100 stalwart Marks & Spencer has struggled in recent years, not least in keeping its fashion offering relevant in the face of fierce competition from online retailers and cheaper high street brands like Primark. The company’s shares fell 3% after its most recent market update on 7 November to below 300p, having been around 330p a year ago.
M&S has been shutting stores as part of its turnaround plan and this has held back revenue and increased costs. Nevertheless, Interactive Investor’s Lee Wild believes that investors are backing M&S to “get the basics right” with a “masterplan” that is in its very early stages. If Steve Rowe, the CEO since 2016, does this, “everything else is at least built on solid foundations”.
Again, M&S's shares have shown resilience in the recent choppy market conditions. Hargreaves Lansdown's senior analyst, Laith Khalif, notes: "In the recent market turmoil M&S actually shored up its position in the FTSE 100, as its shares rose by 2.5% in October, set against a 5% fall in the wider UK market. With a reshuffle in the benchmark index looming in early December, recent share price performance is somewhat of a saving grace."
In this week’s half-year results Rowe admitted that the food division, where sales were down nearly 3%, was performing below expectations. With a dividend yield above 6%, M&S is one of the better payers on the FTSE 100, but a subdued share price plays a part here. A push above 500p in 2013 proved shortlived for the share price, which is roughly at levels last seen 10 years ago.
Taking on Amazon
With a market share of just over 10%, Morrisons can’t match Tesco or Sainsbury’s for scale, but the shares have outperformed the FTSE 100 this year and have proved defensive during recent volatility. The shares yield above 2%.
While Morrisons was late to ecommerce, the company uses Ocado (OCDO) technology and even supplies goods to Amazon so appears to be “open to new opportunities”, says Emma-Lou Montgomery, associate director at Fidelity Personal Investing’s share dealing service.
She adds though that “Amazon ultimately remains the enemy of the sector”. This threat was a major reason why Sainsbury’s acquired Argos, which already has an advanced ecommerce operation.
Sainsbury’s proposed merger with Walmart-owned Asda stunned investors in May this year. While still subject to regulatory approval, the planned deal is a sign of the pressure that UK retailers are under to consolidate and take on Amazon directly. A merged Sainsbury's/Asda would become Britain's leading grocer, overtaking Tesco with a market share of over 30%.
Sainsbury’s half-year profits this week were mixed – on an underlying basis, profits were up from £251 million to £302 million. But taking into account exceptional costs relating to restructuring and the takeover of Argos, pre-tax profits were down from £220 million to £132 million.
Sainsbury’s shares are up over a pound from a year ago at 323p as investors have backed the Argos takeover and planned Asda tie-up. They also rose during October when the FTSE 100 fell along with wider global markets. Dividends above 3% a year are also higher than the retail sector average.
Morningstar analyst Ioannis Pontikis recently hiked the fair value estimate for Sainsbury's from 231p to 360p, but warns that if the competition authorities reject the Asda deal, the fair value would drop to 256p. He argues that the deal would make sense for both grocers, and allow Sainsbury's to lower prices to target the "value-oriented" segment of the market.
