Are Tesco PLC, WM Morrison Supermarkets PLC And J Sainsbury plc Value Traps Or Value Plays?

Should value investors take a look at Tesco PLC (LON: TSCO), WM Morrison Supermarkets PLC (LON: MRW) and J Sainsbury plc (LON: SBRY)?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Value investors love searching in the market’s rubbish bin for the best deals. A list of the stocks currently trading at a 52-week lows is a great place to start when looking for companies that have lost favour with investors. 

Tesco (LSE: TSCO), Morrison (LSE: MRW) and Sainsbury’s (LSE: SBRY) have made several appearances on the 52-week lows list during the past year. But the key question is, are these retailers value plays or value traps? 

Value trap

Value traps are difficult to spot and finding them isn’t an exact science. More often than not, investors find themselves being sucked into a value trap without realising it. 

Nevertheless, most value traps have key three common traits — and by avoiding companies that display these characteristics, you can increase your chances of avoiding these traps. 

Still, as mentioned above finding value traps isn’t an exact science, and while it’s possible to improve your chances of avoiding traps, it’s not possible to avoid them entirely.

Secular decline 

The first common characteristic of value traps is that of secular decline. Simply put, the company may be serving a market that no longer exists in the way it used to.

No matter how good the company is at what it does, if the sector itself is contracting, the firm will struggle to instigate a turnaround. It may also be the case that the company needs to change its business model. 

Now, here’s the thing, all three retailers — Sainsbury’s, Tesco and Morrisons — are struggling to instigate a turnaround in an industry that’s currently undergoing a huge structural change. The rise of the discounters has forced all three retailers to rethink their strategy. 

That said, the food retail sector as a whole is unlikely to become irrelevant any time soon. Tesco, Sainsbury’s and Morrisons are still relevant, and serve a huge market. 

Destroying value 

The second most common trait of value traps is the destruction of value. In other words, investors need to ask if the company’s management has destroyed shareholder value by overpaying for acquisitions and misallocating capital?

Unfortunately, all three of the retailers are guilty of destroying value. Tesco, Sainsbury’s and Morrisons have all announced hefty property writedowns this year, wiping out billions in shareholder equity.

Tesco’s £7bn property writedown helped contribute to the company’s £6.4bn full-year 2014/2015 loss and Sainsbury’s near £800m writedown resulted in the company reporting its first full-year loss for a decade. Also, during the past month Morrison has announced a £30m loss on the sale of its convenience store portfolio. 

Cost of capital 

The third and final most common trait of value traps is a low return on capital invested. Put simply, if a company continuously earns a lower return on invested capital (equity and debt invested in the business) than the group’s cost of capital (debt interest costs), it deserves to trade below book value. 

Here are the key figures for each company. 

Company 

Tesco

Sainsbury’s

Morrison

3-yr Average ROIC

-5.9%

5.5%

5.8%

Cost of Capital Est. 

6.8%

6.6%

9.0%

Current P/B 

2.0

0.8

1.0

Based on these figures, all three of the retailers any deserves to trade below book value as they are destroying value for shareholders.

Overall, Tesco, Morrisons and Sainsbury’s all look like value traps to me.

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.

Rupert Hargreaves owns shares of Tesco. 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.

More on Investing Articles

Black woman using loudspeaker to be heard
Investing Articles

I was right about the Barclays share price! Here’s what I think happens next

Jon Smith explains why he still feels the Barclays share price is undervalued and flags up why updates on its…

Read more »

Investing Articles

Where I’d start investing £8,000 in April 2024

Writer Ben McPoland highlights two areas of the stock market that he would target if he were to start investing…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Ahead of the ISA deadline, here are 3 FTSE 100 stocks I’d consider

Jon Smith notes down some FTSE 100 stocks in sectors ranging from property to retail that he thinks could offer…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

Why I think Rolls-Royce shares will pay a dividend in 2024

Stephen Wright thinks Rolls-Royce shares are about to pay a dividend again. But he isn’t convinced this is something investors…

Read more »

Investing Articles

1 of the best UK shares to consider buying in April

Higher gold prices and a falling share price have put this FTSE 250 stock on Stephen Wright's list of UK…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

The market is wrong about this FTSE 250 stock. I’m buying it in April

Stephen Wright thinks investors should look past a 49% decline in earnings per share and consider investing in a FTSE…

Read more »

Black father and two young daughters dancing at home
Investing Articles

1 FTSE 250 stock I own, and 1 I’d love to buy

Our writer explains why she’s eyeing up this FTSE 250 growth phenomenon, and may buy more shares in this property…

Read more »

View of Tower Bridge in Autumn
Investing Articles

The FTSE 100 is closing in on 8,000 points! Here’s what I’m buying before it’s too late!

As the FTSE 100 keeps gaining momentum, this Fool is on the lookout for bargains. Here's one stock he'd willingly…

Read more »