There’s more value in Tesco (LSE: TSCO) and Booker (LSE: BOK) than in Morrisons (LSE: MRW) and Sainsbury’s (LSE: SBRY) right now, I’d argue — but you may well wonder whether Morrisons and Sainsbury’s should merge, either flipping some of their assets to interested parties or just writing them off.
Tesco
After an impressive rally, Tesco shareholders were punished on 22 April when Britain’s largest retailer informed the market that it would write off about £7bn of assets — that’s the price to pay for long-term value. A leaner Tesco is not the bet of the century, but could easily dictate a premium over its smaller rivals Morrisons and Sainsbury’s — both of which have a good chance to disappear from your trading screen in the next 24 to 48 months, in my opinion.
Tesco shares are now trading at 229p, only 4p below the level they record on the day before its annual results were announced last month. The stock has risen 3.3% ever since, although not much news has been reported, aside from the fact that Tesco has named Deloitte as its new auditor, essentially ditching PricewaterhouseCoopers (PwC). “We and PwC mutually agreed that they would not take part in the tender process. PwC will therefore stand down as the company’s auditors at the conclusion of the 2015 annual general meeting,” Tesco said on Monday.
Personally, I’d add exposure and pay attention to market share and inflation figures in this quarter.
Booker
Booker, which currently trades around 148p a share, is a wholesaler with a market cap of £2.6bn and an enterprise value of £2.5bn. A solid balance sheet is the first element to like, which also differentiates it from many food retailers.
Furthermore, its forward multiples may seem demanding based on earnings and cash flows, but assuming they remain constant into 2017, which is my base-case scenario, capital appreciation could easily be in the region of 20%-30% over the period, spurred by growth in net earnings and cash flows.
Its core margins have been rising ever since 2009, and if Booker keeps up growing revenues, it could certainly surprise investors. I think its management team has done an excellent job in recent years, although it has become more difficult to create value since early 2014.
One Loser In The Retail World
Margins and growth are big problems for Sainsbury’s and Morrisons, both of which reported their financials last week. Had it not been for the General Elections, their shares would have ended the week with big losses.
In a shrinking market, the most recurring question right now is which big supermarket chain will fail under the pressure of fierce competition. Neither Sainsbury’s nor Morrisons are having the best of times and, as they continue to shrink to preserve declining levels of profitability, the more likely scenario to me becomes a partnership or, quite simply, a merger between the pair.
If you think I have lost the plot – well, I am in good company.
Andy Clarke, the chief executive of Asda, expects further consolidation among food retailers. “There are fewer retail fascias on the landscape today than 10 years ago, even three years ago. If you look forward 10 years I am pretty sure there will be fewer again. Making a call on who is, of course, the big question. But I am sure there will be further consolidation,” he recently said.
Results from Sainsbury’s last week were disappointing.
Sainsbury’s is showing clear signs of stress, and — based on its cash conversion cycle, one-off charges and write-offs, market share figures, trends for revenue, earnings and cash flows as well as a few other variables — it remains the weakest food retailer in the marketplace, and that’s reflected in its valuation. That’s not to say that Morrisons is in great shape, but I am confident its new management team would favour a deal aimed at preserving the long-term interests of shareholders.
