We’ve seen a profound change in the way we shop for groceries since the days of market stalls and independent grocer shops. The Co-op dominated the high street of my youth with an occasional trip to Marks & Spencer for special occasion food. Latterly the big supermarkets like Tesco (LSE: TSCO), J Sainsbury (LSE: SBRY), Morrisons and Asda charged ahead, steamrolling independent shops and dominating the food retail business with their tempting offers, all-encompassing stock levels and bright aisles.
In recent years, however, these stars have lost their shine and the big four have seen sales slow and profits slump as in the face of the onslaught from European low-price stores Aldi and Lidl.
So, are FTSE 100 supermarkets still worth investing in, or is their time almost up?
Tesco’s turnaround
Currently worth £23bn, Tesco has undergone a remarkable turnaround over the past five years in no small part thanks to its CEO Dave Lewis, who has unfortunately announced he is leaving.
However, the company has a 2% profit margin and less than 4% operating margin. These are very thin margins and if a no-deal Brexit happens, they will be severely tested when prices are hiked on imported goods and the value of the pound sinks further.
The company has ambitious plans, including opening 150 more Tesco Express branches over the next three years, along with four new superstores. It’s cut down on plastic waste and is introducing more plant-based products to meet customer demand. The purchase of wholesaler Booker is proving a good buy as it now supplies chain restaurants, corner shops, farm shops and delicatessens. It also has a growing number of own-label products that offer higher margins, and its own discount chain Jack’s.
Tesco’s loyalty scheme still outshines all others and is beneficial to both sides. It gains a huge amount of knowledge about its customers, but it also builds customer loyalty.
Its debt ratio is 48% so there is room for manoeuvre there, but high debt is not something I think it should recklessly pursue. Its price-to-earnings ratio is nearing 18, which is no longer bargain territory and its dividend yield is 2.4%. There is growth potential here, but economic and political pressures remain a concern.
Sainsbury’s strengthens
Slightly-higher-end rival Sainsbury’s has also seen a turbulent time of late. This was due to tough trading conditions, which reduced profits and trimmed margins, besides a failed merger with Asda, which could have potentially added £7bn to its value.
the Sainsbury’s profit margin is 0.75% and its operating margin is 1.1%, so they are almost as low as you can go. However, its debt ratio is lower than Tesco’s at 30% and it offers a nice dividend yield of 5%.
It is now on a cost-cutting mission to reduce expenses by £500m in the next five years. This will include closing around 60 Argos stores, integrating them into its supermarkets, along with the closure of 15 supermarkets and 40 convenience stores. However, in addition to the closures, it intends to open approximately 120 convenience stores.
I don’t think the chain is likely to go into administration any time soon and the Sainsburys share price rose almost 12% in September, which makes me think it’s making the right moves to strengthen its future.
Personally, I’d opt for Sainsbury’s over Tesco, as a stock to buy, because it offers a better dividend yield.
