Sector Focus
After a year of slowing sales and profit warnings, the UK's three big supermarket groups -
| Company | Current PE ratio | 10-year PE low | 10-year PE high | 10-year average |
|---|---|---|---|---|
| Sainsbury (J) | 12.4 | 9.7 (Mar 03) | 44.1 | 19.3 |
| Tesco | 9.8 | 8.1 (May 12) | 21.2 | 14.9 |
| Morrison (WM) | 9.9 | 9.6 (Nov 12) | 135 | 26.5 |
| Company | Current dividend yield | 10-year DY high | 10-year DY low | 10-year average |
|---|---|---|---|---|
| Sainsbury (J) | 4.70% | 7.6% (Mar 03) | 1.40% | 4.10% |
| Tesco | 4.30% | 5.0% (May 12) | 1.90% | 3.00% |
| Morrison (WM) | 4.20% | 4.3% (Nov 12) | 1.20% | 2.20% |
Source: Thomson Datastream
Festive flop
Times are undeniably tough for the supermarket sector and Christmas is expected to bring little cheer. While Verdict, a retail market research company, expects food sales over Christmas to rise by 2.9 per cent, the increase will actually be driven by inflation and volumes will, in fact, contract by 0.5 per cent to a "worryingly low" level. And next year volume growth is expected to be just 0.2 per cent, with stubbornly high inflation taking the overall sales growth to 3.1 per cent.
"Not only will 2013 be a difficult year for suppliers, but retailers and consumers will continue to feel increased inflationary pressures, and with the global food supply set to remain volatile, we expect this to continue," says Andrew Stevens, retail analyst at Verdict.
For their part, supermarkets have been sheltering consumers from inflation, partly by absorbing the rising costs and partly by forcing producers to cut their prices. But with food and oil prices set to continue their upwards trajectory following recent poor harvests, many shops will find it difficult not to pass the pain on to cash-strapped customers.
"Seemingly long gone are the days when core domestic markets delivered sustainable share gains," laments Clive Black, analyst at Shore Capital. "Rather, the economic recession has led to domestic challenges to market share and often sustained periods of negative like-for-like sales with low single-digit total revenue growth. While in international markets, sales advances are also lower."
Worst not over
This trend was evident this month when
Morrison has also endured a rough ride this year as all the major supermarkets compete aggressively to attract customers. When the group reported falling half-year like-for-like sales and profits in September, chairman Sir Ian Gibson pointed to commodity price inflation and fragile consumer confidence as two of the biggest challenges. A third-quarter trading update cited lower than expected sales - sales were down 0.4 per cent and like-for-like sales declined 2.1 per cent.
And despite concerted efforts by Tesco and Morrison to freshen up their appearance and improve the quality of their offers, broker Espirito Santo's latest UK consumer survey found shoppers' perceptions of them are deteriorating. That survey suggested shoppers favour Sainsbury (SBRY), with 26 per cent of consumers doing most of their shopping at Sainsbury, up from 9 per cent in the first quarter.
Espirito Santo analyst Caroline Gulliver expects Sainsbury's positive sales momentum to continue and accelerate. The stock has outperformed this year, rising 20 per cent, as the company has gained market share and increased like-for-like sales. Ms Gulliver expects Sainsbury to experience 1.8 per cent like-for-like growth in 2013-14, compared with nothing from Tesco and -1.5 per cent from Morrison. She also thinks the latter two supermarket groups are likely to warn on profits in the next 12 months.
Margin squeeze
It is the peripheral grocers catering to the low and high ends of the market that appear to be thriving in the current environment. For example, data from consumer research company Nielsen showed value supermarket Aldi grew its share of grocery market spend by 39 per cent during the 12 weeks to 10 November and Waitrose by 10.1 per cent. Compare this with 7.4 per cent for Sainsbury, 2.8 per cent for Tesco, 0.9 per cent for Morrison and -1.1 for the Co-operative.
Competition from smaller players is also increasing. Aldi intends to open another 40 stores in the UK next year, some of which will be small high-street stores, threatening the likes of Tesco Metro and Sainsbury's Local. Meanwhile, non-food sales are under threat from tech-savvy shoppers searching online for the best bargains.
To add to the supermarkets' problems, the sector has also come under pressure from regulators. The Office of Fair Trading (OFT) recently criticised supermarkets for the "potentially confusing" way they displayed promotions and discounts, and the groceries code adjudicator has even been given the power to impose fines, which British Retail Consortium director general Stephen Robertson branded a major letdown and a "disproportionate piece of legislation".
To entice cautious shoppers through the door, supermarkets have been spending more on advertising, while increasing voucher give-aways and aggressive promotions. This competitive environment, coupled with rising costs, is putting margins under pressure. Espirito Santo expects Sainsbury's operating margins to hover around 3.7 per cent in 2013, rising to just 3.8 per cent in 2014.
Falling like-for-like sales at Tesco will lead to a decline in group operating margins to 5.1 per cent in this financial year, dropping to 4.8 per cent in 2014. Shore Capital has downgraded its forecasts for Tesco's profits three times already this year, saying it needs to stabilise UK market share with stable UK trading margins of at least 5.2 per cent if the shares are to appreciate. As for Morrison, Espirito Santo believes its operating margin is unsustainable and will fall to 5.4 per cent in 2013 and to 5 per cent the following year.
Forecasts source: Espirito Santo Investment Bank
Favourites
Sainsbury's is well-placed to ride out the economic doldrums. Even if it doesn't grow hugely over the next few years, it is favoured by consumers and has a tempting forecast dividend yield of 5 per cent. In the last financial year, it rewarded shareholders by increasing its full-year dividend payment by 6.6 per cent to 16.1p. Priced at 11.2 times forecast earnings, it is not as close to historic lows as its peers, but is delivering much better growth.
Despite all of Morrison's woes, management does seem to be making the right moves. For example, the stores and products are being spruced up and the company is starting to open superstores again. The supermarket is following Tesco and Sainsbury by investing in convenience stores and, while its absence from online shopping is acute, it has opened an online wine operation. At 264p, the stock is inexpensive relative to its sector and trades at a discount on 9.9 times expected earnings. Last year, the board established a policy of maintaining a progressive dividend and increasing payments by a minimum of 10 per cent a year to 2013-14, and so far it has made good on the promise.
Outsiders
Trading on a forecast earnings multiple of 9.9, Tesco's shares are very cheap by historic standards, but falling sales and pre-tax profits are concerning, as is its difficulties in international markets. In the first half of the year, pre-tax profits were down 11.6 per cent. The supermarket is one year into a six-point recovery plan, but brokers have nonetheless cut profit forecasts several times already this year, and downgraded earnings further after its third-quarter trading statement.
IC VIEW:
Growth is sluggish, margins are under pressure and new players are taking market share. Broker Seymour Pierce has said it sees "much more interesting investment opportunities elsewhere in the non-food sector". But, despite the raft of challenges facing the supermarkets, shopping for groceries accounts for 44 per cent of retail spending and, in the end, people still have to eat. Given this, those companies that are successful in attracting shoppers and can adapt the way they do business to the changing retail landscape could offer investors real rewards from current low levels.
BROKER VIEW:
By Clive Black, analyst at Shore Capital
British supermarkets resemble a bar bell in their relative performances, with the discounters and premium retailers generally gaining market share from the big guys in the middle. Those big guys have largely found the last two years reasonably tough going with pressurised consumers restricting volume purchases and what sales growth there has been coming through price, convenience and online. Accordingly, what was for a long time considered to be a defensive sector has lost its lustre with investors and has been de-rated with downgrades to earnings more common than upgrades.
Few players in the retail trade anticipate that 2013 will be a golden year. The prevailing view is one that is pretty widespread in the UK - an economy roughly going nowhere. With inflation still exceeding wage growth, albeit more narrowly these days, disposable incomes can be expected to remain under pressure. Demand, therefore, is likely to be a little better, but not much. Price rises are expected to again feature for the first half of the year at least, until the northern hemisphere harvest is understood, and so promotions and price-matching are expected to remain the prime mechanism to support volumes and proclaim value. We do not anticipate a price war, but one can never say never.
Within this constrained context, 2013 will be a big year for Tesco, as it seeks to demonstrate market stabilisation in the UK, while meeting the challenges of Fresh & Easy, Korean opening hours restrictions and the low tide of European economic activity. Key to Tesco's prospects will be stable domestic margins corresponding with stable share, but there could be a prize for investors if capital expenditure is paired back again.
Sainsbury has been commendably outperforming, although the cost of competing limits margin expansion. We see more of the same from Sainsbury, but perhaps against a better competitor in Tesco. We worry about Morrison - its trading momentum has been poor recently and stabilisation may require margin investment. Further downgrades to profits are not out of the question.
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