Five years ago Tesco (LSE: TSCO), Sainsbury’s (LSE: SBRY) and Morrisons (LSE: MRW) were FTSE 100 champions, and it seemed that these retailers could do no wrong.
How times have changed. Over the past five years, these three supermarkets have become the poster children of the declining British retail sector, and investors have borne the brunt of the losses stemming from their troubles.
Over the past five years, shares in Tesco have lost around 60% of their value, excluding dividends. Shares in Morrisons have lost 35% of their value excluding dividends and shares in Sainsbury’s are down by around 20% since the beginning of May 2011. Over the same period, the FTSE 100 has gained 2.3%, which doesn’t seem like much at first glance but these gains exclude dividends. Including reinvested dividends, the FTSE 100 has returned approximately 20% during the past five years.
The retail environment has changed significantly
Unfortunately, it could be years before Tesco, Sainsbury’s and Morrisons return to their former glory. Indeed, the retail environment has changed considerably over the past five years. The rise of Aldi and Lidl has shaken the sector to its core while changing consumer habits have almost rendered large superstores redundant. These two structural changes have really hurt the UK’s three largest supermarket retailers, which have spent the last two or three decades building their empires on fat profit margins and the notion that consumers like large superstores.
There’s no denying that the food retail industry has changed significantly over the past five years. These changes have left retailers earning lower profit margins and lower returns on capital — the money invested in the business.
Take Tesco for example, at its height, the company was earning an operating profit margin of 6.5% and a return on capital employed of 14.7%. However, last year the company’s operating profit margin slumped to -9.3%, or less than 2% excluding one-off costs, and return on capital employed fell to 4.1% for the year.
The problem is that this performance wasn’t just a one-off, it’s a reflection of the pressures that the grocery sector is now facing. Sainsbury’s and Morrisons are both facing similar pressures. And to try and combat changing consumer habits, Sainsbury’s management has made the decision to chase a tie-up with Home Retail group to boost profit margins by using empty space in stores to cross-sell products. Meanwhile, Morrisons is selling off assets and going back to its low-price background to try and increase sales. Only time will tell if these two strategies will work.
The bottom line
Overall, it’s going to take a long time and an enormous amount of effort for Tesco, Sainsbury’s and Morrisons to return to their former glory. These companies were caught out by shifting sands in the retail sector and are now struggling to adapt to the changing market conditions. Sainsbury’s currently trades at a forward P/E of 13, Tesco trades at a forward P/E of 62.4 and Morrisons trades at a forward PE of 18.6 with Tesco looking particularly expensive.
