The Bank of England’s views on the future for the UK economy should indicate that things are about to get much better for supermarkets such as Morrisons (LSE: MRW) (NASDAQOTH: MRWSY.US) and Sainsbury’s (LSE: SBRY) (NASDAQOTH: JSAIY.US). That’s because, while the growth rate of the economy has been revised down for the next few years, it is still a relatively upbeat outlook, with many jobs set to be created and consumer confidence forecast to improve at a brisk pace.
Furthermore, inflation is expected to remain at or near zero for the remainder of the year, with it due to be well below the Bank’s 2% target over the medium term. As such, wage rises are expected to beat inflation and provide UK consumers with a real terms increase in their disposable incomes, with this situation set to last for a number of years.
As a result, Morrisons and Sainsbury’s should, in theory, see demand for their products increase, as price becomes a less important part of the decision-making process for shoppers, and customer service and the range of products on offer take on a more important role. This should mean, then, that no-frills operators such as Aldi and Lidl become less popular, and the squeeze on mid-price point operators such as Morrisons and Sainsbury’s starts to abate.
The problem, though, is that evidence of this taking place is rather thin on the ground. In fact, Mike Coupe, the CEO of Sainsbury’s, recently said that an increase in disposable incomes in real terms was having a negative impact on the company’s sales numbers. That’s because shoppers are apparently choosing to treat themselves to more takeaways and restaurant experiences, rather than using their greater spending power to buy higher price point groceries. Thus far, then, an improvement in the UK consumer outlook has done little to help Morrisons and Sainsbury’s.
That’s not to say, though, that it will not improve their performance moving forward. After all, the last handful of years have been so tough for hardworking families across the UK that it is perhaps to be expected that it will take time for the anticipated shift towards higher price point supermarkets to take place. According to the companies’ forecasts, though, this is expected to happen, with both Morrisons and Sainsbury’s due to report bottom line growth by financial year 2017.
And, with both supermarkets trading at very low valuations, they seem to be hugely cheap. For example, Morrisons has a price to book (P/B) ratio of just 1.18, while Sainsbury’s has a P/B ratio of just 0.96. Certainly, there may be asset write-downs over the next couple of years, but both supermarkets appear to offer very wide margins of safety to factor in this risk.
So, while their performance is continuing to disappoint and is showing little sign of improvement even with a stronger outlook for UK consumers, Morrisons and Sainsbury’s appear to be worth holding on to. They may be slow burners but, in the long run, such low valuations indicate that there are considerable capital gains on offer.
