Buying shares in Sainsbury’s VS Tesco – The good, the bad and the UGLY
I am an analyst, trader and recruiter for Samuel & Co Trading, a company with an accredited international trading program for those looking to make a foray into the financial industry and those utilising trading algorithms. I enjoy trading FX and equities - also interested in price action and macroeconomic factors that may affect the financial markets.
Over the past few years, the share price of grocery dominators Sainsbury’s and Tesco have had a tumultuous ride, one could say similar to a trolley with a wobbling wheel. Supermarket stocks are seen as defensive stocks and those looking to invest in a defensive stock long term would surely look for reliable and sustainable growth as well as a steady dividend. Sainsbury’s pays out a 4.51% dividend, which is higher than the bottom 25% of dividend payers in the UK and just 0.70% below the top 25%.
The share price performance since 1999 is as follows:
January 1999 – present: -40%
January 2004 – present: -12%
January 2009 – present: -15%
January 2014 – present: -20%
We can see below the health of Sainsbury’s income statements, balance sheets and cash flow since 2012. Total equity and free cash have been increasing over the past few years, however, net income appears to be decreasing, perhaps accentuated by the company’s decision to acquire Argos. Brokers are also majority weighted to a hold rating, the stock not expected to outperform the market.
CEO Mike Coupe’s decision to acquire Argos in September 2016 may not have been the best decision. Whilst sales have increased, profit margins have continued to fall so it appears Argos’ products are less profitable than groceries!
Most recently, the proposed Sainsbury’s/Asda merger that was supposed to combine the two giants fell through as the Competition and Markets Authority said that it had found “extensive competition concerns”, also saying the merger would create a “substantial lessening of competition at both a national level and local level”. Its findings sent shares in Sainsbury’s down by 15%, to 245p and dragged down other grocers, with Morrisons also dropping 4.6% in reaction to the news. If Sainsbury’s were to merge with Asda, the market share would be over 31% and controlling nearly 60% of all groceries sold in the UK. Tesco currently has the largest market share of the supermarket sector, around 27% which is currently decreasing YoY as budget supermarkets Lidl and Aldi gain in popularity. CEO Coupe, who had said the deal would give shoppers a 10% cut in the price of popular foods, said in regards to the CMA’s comments: “They have fundamentally moved the goalposts, changed the shape of the ball and chosen a different playing field”.
That being said, the level of Sainsbury’s debt compared to their net worth is reducing and the current level of debt (35.5%) compared to their net-worth is healthy, they also pay a reasonable yield dividend. From a technical point of view, the stock is currently at the interesting 225p level, of which the price hasn’t made a substantiated foray below. This level was previously tested back in 2003 and came close again at the height of the financial crisis in 2008, but halted around 236p.
You may be able to squeeze some profit trading the dead cat bounce, but from a fundamental point of view, the direction of the company in the mid-longer term is quite uncertain. The merger appears to have fallen through, the share performance isn’t incredibly promising and with increased competition from larger grocers as well as up and comers, we could see Sainsbury’s market share dwindle further depending on how the price reacts to the current level.
If you aren’t looking for as much risk investing in the grocery sector, you may want to accumulate shares in Tesco which has more impressive earnings growth and growth forecasts. Tesco’s intrinsic value based on a future cash flow calculation is at 411p compared to its current share price of 228p, perhaps indicating further upside to come. Below we see Tesco’s tumultuous income statement, especially in 2015 where they were almost minus £6 billion in the red. The past 3 years have been positive, but lacklustre. The balance sheet has also been up and down over the past few years, but we see Tesco actively reducing debt, whilst their total equity increases. Cash is also increasing as they are starting to close stores that are performing poorly and bleeding resources. The current broker rating is positive, with 19 brokers rating the company and overall buy, meaning the majority of analysts expect the company to outperform the market.
From a technical point of view, Tesco’s price appears to have started to change direction in the winter to summer period of 2016, ending the almost 9-year stint of underperformance, annotated on the cart below. The positive change in trading performance and the sentiment was helped along initially by additional product line launches, changes to spending/store space as well as M&A rumours and exec/board changes.
A fundamental concern to account for when looking into Tesco could be the ultimatum presented by German discounters Aldi and Lidl, of which Lidl was recently awarded the ‘Best Grocer’ title at the Retail Week Awards. As these grocers continue to boldly accrue market share, the pressure is then put on to larger supermarkets like Tesco and ASDA to discount their products further, in order to stay competitive with the new kids on the block; in turn, decreasing profit margins. For the 12 weeks up to 30th December 2018, all the major supermarkets lost market share, while Aldi’s sales jumped 10.4%, and Lidl’s by 9.4%. This took their combined market share to a record high of 12.8%, up an impressive 12% on the year before. Fascinatingly, around two-thirds of UK households visited an Aldi or Lidl supermarket over Christmas, which again goes to show the popularity of these businesses today.
Thanks for reading!
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CMA quotes obtained from: J Sainsbury PLC / Asda Group Ltd merger inquiry - GOV.UK
Lidl/Aldi figures obtained from Fool.co.uk