COMMENT
Tesco Is Still Your Best Bet

By Ed Bowsher (TMFArkle)
December 21, 2005

This is a crucial week for UK food stores as consumers stock up on turkey and mince pies. So should Fools try to cash in by buying shares in the supermarket chains?

Somerfield was delisted today, so your choice of companies is now down to three.

Let's start with William Morrison (LSE: MRW), which is often touted as a recovery play. The company has had a tough time in the aftermath of its botched takeover of Safeway, but bulls point to the value in the company's store estate. They also remember that Morrison was a highly successful retailer before the Safeway debacle.

What's more, the board hopes to appoint a new CEO next year to turn things around.

The problem is this: much of that turnaround is already in the share price. Shares in Morrison are currently trading at 190p, yet Seymour Pierce reckons that earnings will come in at 7.8p per share in 2007. That puts Morrison on a forward price/earnings ratio of 24!

Sure, the performance may improve further after 2007. If things went really well, we might see earnings reach 15p towards the end of the decade. But that figure is far from certain and price-driven competition from Tesco (LSE: TSCO) and Asda isn't going to let up. Indeed, I think the revival of Asda could be one of the big retail themes of 2006.

So I'm not tempted to buy shares in Morrison.

I'm not attracted to Sainsbury (LSE: SBRY) either. Sainsbury is further down the recovery path than Morrison, and there's no doubt that chief executive Justin King has done a good job sorting out the problems bequeathed by the previous regime.

But once again, too much good news is already in the price. Earnings of 12.9p a share are forecast for 2007, which puts Sainsbury on a forward price/earnings ratio of 24, just like Morrison. I think that's too high given the company's competitive position. After all King's good work, like for like sales only rose by 2.1% in the first half. And it's not going to get any easier.

King now has to wrestle with two big problems. Sainsbury is too small and it has a weak non-food business. These problems aren't easily solved.

Tesco, by contrast, benefits from economies of scale and a thriving non-food business.

The company took some flak last month because UK like for like sales "only" rose by 5.5% in the third quarter. That figure doesn't worry me unduly. The crucial point is that Tesco is growing faster than its rivals and is the dominant player in the UK food market. On top of that, Tesco's international business is beginning to crank up nicely.

Admittedly, Tesco's share price isn't at bargain basement levels. At 330p, it's trading on a forward price/earnings ratio of 15. But take comfort from this thought. You're buying shares in a quality retailer which still has plenty of growth potential.

There's no doubt in my mind. Tesco is the best of the bunch.