Is A Profit Warning Around The Corner At Tesco PLC & J Sainsbury plc?

Tesco PLC (LON:TSCO) and J Sainsbury plc (LON:SBRY) are faced with a few problems, argues Alessandro Pasetti.

| 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.

A profit warning would be a big blow for Tesco (LSE: TSCO) and Sainsbury’s (LSE: SBRY), but just how likely is that? 

No Signs Of Recovery

Wal-Mart’s British supermarket chain Asda slumped to its worst quarterly sales performance in the 16 years it has been owned by the U.S. group, with results on Tuesday highlighting its struggles in the face of an onslaught from the discounters,” Reuters reported this week. 

There are no “signs of green shoots“, according to chief executive Andy Clarke. 

The fundamental problem at the big four in the food retail world is that promotions should be aimed at winning back market share from their German rivals, but it looks like a price war is the most obvious outcome — and this could be a long war game indeed. 

Financials

Sainsbury’s is informally guiding the market to £650m of operating income (Ebit) this year, which is about £150m below the level that the grocer recorded last year, for an implied Ebit margin of 2.7%. Just like at Tesco, there’s limited room for error. 

That level of core profitability should yield earnings per share of about 20p on a statutory basis, but the drop in Sainsbury’s annual EPS could be more painful if sales declines persist and additional price investment is required to preserve market share rather than to win back customers.

Things aren’t much different at Tesco, whose core pre-tax income margin stands at about 2%. 

We said we had an aspiration to get to a level of (trading) profit of £1.4bn for this year,” chief executive Dave Lewis said in a follow-up call with analysts when first-quarter results were announced. 

Tesco has not issued a firm guidance for its fiscal year 2016, but investors expect its operating income to hover around £1.3bn (low estimate $1bn; high estimate £1.4bn), which should yield annual EPS in the region of 8p, although EPS could halve to 4p if the bears are right. Furthermore, if a worst-case scenario plays out, a zero dividend policy becomes a distinct possibility. 

Recent news is less encouraging for the bulls, but it’s possible that a nightmare scenario is already priced into the shares of both Tesco and Sainsbury’s, at least based on the fair value of their assets, in my view — yet big risks remain. 

Stats

The Office for National Statistics (ONS) said on Thursday that “year-on-year estimates of the quantity bought in the retail industry grew for the 28th consecutive month in July 2015,” up 4.2% compared with July 2014.

This was the longest period of sustained year-on-year growth since May 2008, BUT increases “reported by department stores, other stores, household goods stores and non-store retailing (were) offset by falls in predominantly food stores, textile, clothing and footwear stores and petrol stations.

Well, trends are not good.

Also consider this: the value of online sales, which are important for future growth at both food retailers, increased by 13% in July 2015 compared with July 2014, yet there was no growth at all in July 2015 compared with June 2015. 

Finally, there’s talk that food retailers may invest more in their supply chains to pursue a deeper level of vertical integration, which would help them promote and sell private-label goods, hence preserving margins. 

I doubt that’s a solution, given the favourable terms that most food retailers enjoy with their suppliers. 

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.

Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK owns shares of Tesco. 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

Jumbo jet preparing to take off on a runway at sunset
Investing Articles

Down 70%+ since 2020, is IAG’s share price an unmissable bargain?

IAG’s share price is still down around 73% from its pre-Covid level, but with the business performing well last year,…

Read more »

A pastel colored growing graph with rising rocket.
Investing Articles

£17,000 of shares in the FTSE 100 dividend giant can make me £18,874 every year in passive income!

This FTSE 100 dividend superstar has an 8.8% yield with dividends projected to rise. It looks very undervalued to me…

Read more »

Investing Articles

2 top UK growth stocks I’m buying for my Stocks and Shares ISA in July

Looking for UK-listed growth firms to add to a Stocks and Shares ISA? Our writer highlights two he's planning to…

Read more »

artificial intelligence investing algorithms
Investing Articles

This overvalued growth stock makes Nvidia look cheap!

ARM Holdings is a growth stock that’s benefitted from the AI rally. Muhammad Cheema takes a look at whether this…

Read more »

Investing Articles

1 penny stock I’d buy today while it’s 63p

This penny stock's down 70% since last March, yet could be set for a big comeback as the firm rebuilds…

Read more »

Businessman use electronic pen writing rising colorful graph from 2023 to 2024 year of business planning and stock investment growth concept.
Investing Articles

Buying 8,617 Legal & General shares would give me a stunning income of £1,840 a year

Legal & General shares offer one of the highest dividend yields on the entire FTSE 100. Harvey Jones wants to…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

£25k to invest? Here’s how I’d try to turn that into a second income of £12,578 a year!

If Harvey Jones had a lump sum to invest today he'd go flat out buying top FTSE 100 second income…

Read more »

Union Jack flag in a castle shaped sandcastle on a beautiful beach in brilliant sunshine
Investing Articles

2 lesser-known dividend stocks to consider this summer

Summer is here and global markets could be heading for a period of subdued trading. But our writer thinks there…

Read more »