2015 was a horror show for the supermarkets, particularly those in the “squeezed middle” of this sector, such as Tesco (LSE: TSCO), Sainsbury (LSE: SBRY), and William Morrison Supermarkets (LSE: MRW).
Up to this point, the UK supermarkets had been growing for years, as they had taken business from the corner shop and the High Street. But trees don’t grow to the sky, and there are always limits to expansion.
2015 was a horror show for the supermarkets
The supermarkets realised this last year. Tesco found that a 2014 net profit of £1.912bn turned to a net loss of £5.572bn in 2015. Sainsbury saw its 2014 net profit of £716m swing to a net loss of £166m in 2015, while Morrisons was already loss-making in 2014, and its losses widened the following year. These retailing giants went from crisis to crisis, and the news flow was unremittingly negative.
For an industry that has been used to consistently churning out profit year after year, it was a shock to the system. Companies had been blindly opening stores, and the result was that competition was now fierce, and retailers were forced to cut profit margins drastically to maintain sales.
The sector has now cottoned on to this, and they have cancelled their store building programmes. Meanwhile they have been working on improving their service to customers, their online and click-and-collect sales, and their product offerings. On visiting my local Tesco or Sainsbury, I have been impressed by the freshness of the produce, and the quality and range of goods on offer.
And things are starting to improve. Tesco has started to grow sales once more, and is now turning a small profit, making £216m in 2016. Sainsbury and Morrisons have also returned to profit, adding to my view that 2016 is a year of recovery for supermarkets.
But they are profitable once again
Yet we need a sense of perspective about this. I think, certainly for the moment, the days of billion pound-plus profits for the UK’s supermarkets are gone. This is now a mature sector that is no longer growing, but needs to maintain a steady state. This means incremental improvements and cost-cutting leading to sales and profits gradually rising.
The share prices of these firms have taken a battering in recent years. The valuations of all three companies have been trending downwards since their peak in the pre-Credit Crunch days of 2007. Is it time to buy in?
Well, checking the 2016 P/E ratios shows that Tesco is on 28.53, Sainsburys is on 12.20 and Morrisons is currently at 22.64. That’s why Sainsbury looks to be the pick of these retailers at the moment. As for Tesco and Morrisons, I think it is way too early to buy in. I would keep a watching brief, to see if the share prices fall further, and if profitability pushes higher.
Because in this stock picker’s market, your investing decisions should be based on one factor above all else: earnings.
