The Shares That Analysts Hate: Tesco PLC and Wm. Morrison Supermarkets plc

Why Tesco PLC (LON:TSCO) and Wm. Morrison Supermarkets plc (LON:MRW) are out of favour with the City experts.

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Right now, Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) and Wm. Morrison Supermarkets (LSE: MRW) (NASDAQOTH: MRWSY.US) are among the most unfavoured stocks of the professional analysts.

Not so super supermarkets

The ‘Big Four’ supermarkets — Tesco, Sainsbury’s, Asda and Morrisons — are being increasingly squeezed for market share by, on one side, discounters Aldi and Lidl, and, on the other, upmarket Waitrose and Marks & Spencer.

Analysts at HSBC are not alone in deducing that: “The UK food retail industry is undergoing the biggest structural change in decades, the enormity of which should not be under-estimated”.

Pointing out that 30-odd years ago the Co-op was top dog in the sector, with a market share of over 25% — bigger than Tesco and Sainsbury’s combined — the HSBC analysts argue that:

“When structural change happens, the enormity is often beyond the scope of the protagonists as the consequences are unthinkable. We believe that from the current change, a new structure will emerge and that the industry will look very different in 5-10 years. Not all are likely to survive. Tesco have the resources to influence this change to its own benefit but it requires significant and decisive action”.

Tesco

Concern that Tesco’s management hasn’t been decisive and bold enough during more than two years of trying to turn around its UK business is widespread among City experts. Analysts at Oriel Securities described the plans outlined at Tesco’s most recent strategy day as just “more of the same”.

tescoBearish analysts see revenue under pressure, margin erosion, and free cash flow failing to cover the cost of the current level of dividend. While the shares are ‘cheap’, on a single-digit forward P/E, analysts at Merrill Lynch suggest that:

“With the increasing risk of earnings downgrades and a dividend cut, we do not expect the shares to benefit from a re-rating until there is increased visibility of margin stabilisation in the UK – we think a long way off”.

The most sceptical analysts have a target price for Tesco in the 240p to 265p range, compared with 285p today.

Morrisons

The general climate in the supermarket sector also informs the City experts’ bear view on Morrisons, but there are company-specific issues for Morrisons, too.

morrisonsWith large stores showing like-for-like volume declines and the large-store openings programme cut, HSBC reckons Morrisons’ total sales line “may be moving structurally backwards, despite the roll-out of convenience and on-line” — the growth areas of the market into which Morrisons has been slow to move.

Furthermore, as the UK’s number four supermarket, Morrisons lacks the economies of scale of Tesco. HSBC’s analysts believe the drawback of Morrisons’ relatively high fixed-costs-to-sales is only compounded in a sales downturn by the company’s vertical, farm-to-fork supply chain.

Morrisons is vulnerable to a price war of attrition. The HSBC analysts assert that “in many ways, Morrisons’ future lies in Tesco’s hands”; and their target price of 160p (current price 202p) is just about the lowest in the City.

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.

G A Chester does not own any shares mentioned in this article. The Motley Fool owns shares in Tesco and has recommended shares in Morrisons.

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