Tesco PLC, Morrisons And The Path To Recovery

Can Tesco PLC (LON:TSCO) & Wm. Morrisons Supermarkets plc (LON: MRW) recover their profits?

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Understanding trends is crucial to investing well: both when trends begin, and also when they end.

Since the middle of the last century, there has been a remorseless trend towards the supermarkets. Britain circa 1950 was a nation of corner shops, of bakers, butchers and fishmongers. But the concept of supermarkets that combined all these small shops into one single market — a ‘supermarket’ — was just emerging.

The end of the trend

Instead of visiting the bakers each day to buy a fresh loaf of bread, you would visit the supermarket once a week to buy all your groceries at once. And you might even be driving in one of those new-fangled ‘motor cars’. Alongside these developments, new food technology and increasingly popular refrigerators meant that groceries such as bread and fruits and vegetables could be kept fresh a whole week.

All of this meant that the supermarkets have been booming for the past 60-70 years, steadily take market share from the corner shops and department stores. In this growth phase of the supermarkets, these companies’ ability to buy to pile it high and sell it cheap would always beat the smaller retailers.

But, just in the past few years, something interesting has happened. The rapid expansion of retailers such as Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US), Sainsbury, Asda and Morrisons (LSE: MRW) (NASDAQOTH: MRWSY.US), which was happening across supermarkets, minimarts and internet shopping, has slowed.

I think, finally, the long-term trend of supermarket growth in the western world is ending. But this is not the only change which the supermarkets are having to contend with. Consumers’ habits are also evolving. You might buy your weekly shopping from Tesco. But during the working week you might buy your lunch from the Marks & Spencer Simply Food down the road. Mid-week you might visit your local Aldi to check out some of the latest bargains. And during the weekend you might buy your son some toys from the Sainsbury website.

The path to recovery

The world of the long tail has arrived. This shows through in the supermarkets’ latest results, with the market share and profits of both Tesco and Morrisons falling.

Is there a path to recovery? Of course there is. I think the supermarkets must embrace change, and not run away from it. This is why Morrisons, in particular, has suffered so much in the past year, as it has missed out on the boom in minimarts and internet shopping. It is remedying this now, and I suspect it will gradually recover market share, but it needs to move fast.

Tesco is much further ahead, as the UK’s leading internet retailer, with a portfolio of over a thousand smaller shops. But it is also suffering, as its market share is chipped away by increasingly fierce competition.

This may be the time to buy, not sell

And yet, both companies have fundamentally strong businesses, which means they can still be hugely successful into the future. But now they must consolidate by reducing prices, improving the variety of produce they offer and the shopping experience, and offering their products across all channels seamlessly. If Tesco works hard to improve its overseas business, it still has enormous potential to grow company profits.

In fact, I will end this article on a surprisingly positive note: with so much negativity swirling about the supermarkets at the moment, I’m beginning to wonder whether these supermarkets are actually contrarian buys. Both supermarkets certainly look cheap, and both are on my watchlist. This may be the time to buy, not sell. Although the era of rapid growth may be over, I think there is still a bright future for the supermarkets.

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.

Prabhat owns none of the shares mentioned in this article.

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