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Is the worst over for these two retailers?

Photo: Rept0n1x. Cropped. Licence: http://creativecommons.org/licenses/by-sa/3.0/

After several years of hardship, it appears as if things are finally looking up for the UK grocery sector. Over the past few weeks, the UK’s biggest retailers have been reporting results for the first nine months of the year, and there are signs of improvement across the board, although it’s clear lots of work still needs to be done.

Leading the pack

Morrisons (LSE: MRW) has reported the best results by far of the UK’s big four supermarkets. Back in September, the company reported better-than-expected numbers, which sent its shares surging. For the first time in four years, first-half profit increased and the company registered the third consecutive quarter of underlying sales growth. Underlying pre-tax profit rose 11% to £157m and sales at stores open over a year grew by 2% in the second quarter versus a 0.7% rise in Q1.

Additionally, net debt fell by £477m to £1.3bn, below management’s target of £1.4bn-£1.5bn for the end of the fiscal year. The company also announced that it would beat its cost savings target of £1bn this fiscal year and hit its goal of £2bn of free cash flow six months early.

The J Sainsbury (LSE: SBRY) recovery story is similar. Yesterday the company reported that underlying group sales for the 28 weeks to 24 September 2016 were up 2.1% year-on-year. However, underlying profit before tax fell 10% to £277m for the period.

Nonetheless, management is excited about the group’s prospects. Sainsbury’s is planning to open a further 30 Argos digital stores and create 30 Argos digital collection points in Sainsbury’s supermarkets by Christmas to make the most of the holiday shopping splurge.

City analysts expect the strategy to pay off although not until next year. For the fiscal year ending 31 March 2017, analysts have pencilled-in an earnings per share decline of 11%. For the year after, earnings are expected to come in unchanged year-on-year.

Making progress

The figures from Sainsbury’s and Morrisons clearly show that these companies are making progress with their restructuring, but there is still plenty to do. That being said, it looks as if these companies have finally halted sales declines, implying that the worst is over for these retailers.And if you’re seeking to make a contrarian bet on the UK supermarket sector, now might be the perfect time. 

Shares in Morrisons and Sainsbury’s still trade at depressed valuations as it would appear that many investors are still giving the sector a wide berth. Shares in Sainsbury’s currently trade at a forward P/E of 12.4 and support a dividend yield of 4.1%. Morrisons trades at a forward P/E of 20.8 but with earnings per share growth of 36% predicted this year, the shares trade at a PEG ratio of 0.6. They currently support a dividend yield of 2.4%, and the payout is covered twice by earnings per share.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.