3 Reasons Why Tesco PLC Still Isn’t As Cheap As J Sainsbury plc & Wm. Morrison Supermarkets plc

Roland Head reveals surprising valuation differences between Tesco PLC (LON:TSCO), J Sainsbury plc (LON:SBRY) and Wm. Morrison Supermarkets plc (LON:MRW).

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tesco2Tesco (LSE: TSCO) shares have fallen by 42% so far this year — further than both J Sainsbury (LSE: SBRY) — down 29% — and Wm. Morrison Supermarkets (LSE: MRW), which is down 33%.

Despite this, Tesco is still more expensive than its rivals on some key measures, as I’ll explain in this article.

1. Book value

Book value — or a company’s theoretical sale value — is important, especially for firms with large property portfolios, low profit margins, and physical stock inventories, such as supermarkets.

 

Tesco

Sainsbury

Morrisons

Share price (24/09/14)

193p

260p

175p

Price/book value

1.06

0.83

0.87

Price/tangible book value

1.42

0.87

1.0

From these figures, it’s clear that Sainsbury’s is currently the cheapest supermarket, trading at just 83% of its book value.

2. Trade price

Professional investors and trade buyers usually prefer to value firms using the EV/EBITDA ratio, rather than P/E.

EV/EBITDA stands for enterprise value (market cap plus net debt) divided by earnings before interest, tax, depreciation and amortisation (EBITDA).

In my view, EV/EBITDA is a very useful measure for private investors, as it enables you to compare the valuation of firms with different debt levels:

 

Tesco

Sainsbury

Morrisons

EV/EBITDA

5.6

4.0

6.9 (forecast)

On this measure, Sainsbury’s is a clear winner, with a very low EV/EBITDA ratio of 4. Tesco also looks affordable, on 5.6.

Morrisons traded at a loss last year, making a calculation impossible, but assuming the firm’s full-year figures are in line with this year’s interim results, Morrisons trades on a EV/EBITDA ratio of 6.9, making it the most expensive of the bunch.

3. Return on capital

Another valuation metric that’s favoured by professional investors is return on capital employed (ROCE) — the return the company generates from its equity and debt capital.

This can be calculated as operating profit / (equity plus debt).

ROCE is an important measure of how profitable a company really is, and enables you to see whether your money could generate a better return elsewhere.

 

Tesco

Sainsbury

Morrisons

Return on capital employed

9.2%

10.3%

7.7% (forecast)

Again, Sainsbury’s scores highest, Tesco second, and Morrisons last, based on last year’s reported figures from Tesco and Sainsbury’s, and this year’s first-half figures from Morrisons.

Which should you buy?

Both Sainsbury’s and Tesco have yet to report their interim results. I expect both to report lower profits than for the same period last year, but Sainsbury’s discount to book value gives it the edge as a buy, in my view.

Morrisons is the only firm that’s in the clear at the moment, as its first-half results were as expected and, in my view, cautiously positive, so I retain my buy rating on the stock.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland owns shares in Morrisons and Tesco. The Motley Fool owns shares in Tesco.

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