I’m looking to buy more FTSE 100 stocks in the days and weeks ahead. But I won’t be adding Tesco (LSE:TSCO) or Sainsbury’s (LSE:SBRY) shares to my portfolio any time soon.
Here’s why.
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Left on the shelf
The meagre margins of UK’s ‘Big Four’ supermarkets are under increased pressure as the industry’s bloody price wars intensify. This is a major threat even during normal economic conditions. But with the cost-of-living crisis enduring, the threat this poses to Tesco is especially significant today.
Latest data from Kantar Worldpanel underlines the scale of the challenge. Okay, the FTSE firm’s sales rose 5.9% in the four weeks to 18 May. However, this was dwarfed by growth of 10.9% and 6.7% at Lidl and Aldi respectively.
Combined growth among the German discounters was at levels not seen since January 2024. And as both businesses commit to continue store expansion, their appeal to an increasingly cost-conscious public should continue to grow.
On the plus side, Tesco’s decades-old Clubcard scheme should help the firm defend itself against these pressures. Its voucher-and-discount programme has made Tesco the industry’s commanding force with an impressive 28% market share. Roughly one in two British adults hold a Clubcard in their wallets.
Still pricier
Yet I fear its influence could be waning as shoppers can still get better deals elsewhere. According to Which?, Aldi was the cheapest supermarket for a basket of 79 branded and own-label groceries in April, charging £135.95. Tesco was way back in fifth place, even factoring in Clubcard (total price: £151.11).
Tesco’s adjusted operating margin edged up in the last financial year to 4.5%. However, it could struggle to keep them around this level if, as is likely, the business slashes prices to keep store footfall and website clicks ticking over.
Despite its problems, Tesco’s shares continue to attract a princely valuation. They trade on a price-to-earnings (P/E) ratio of 14.4 times, which is above the 10-year average of roughly 12.5 times.
Given the challenging trading environment, I feel this leaves the grocer in danger of a price correction.
Another FTSE share I’m avoiding
Like Tesco, fellow ‘Big Four’ operator Sainsbury’s has substantial brand power and an effective loyalty programme (in this case, Nectar). But it’s embroiled in the same ‘race to the bottom’ that’s engulfing the broader industry.
In fact, with even weaker margins, it has less wiggle room to reduce prices without decimating earnings. J Sainsbury’s retail underlying operating margin also rose in the last fiscal year but remained wafer-thin, at 3.17%.
Through its Argos general merchandise division, Britain’s second-biggest supermarket is also more vulnerable to weaker discretionary spending than the broader industry. Sales here dropped 2.7% in the last financial year, pulling total annual sales growth (excluding fuel) down to 3.1%.
Yet similar to Tesco, Sainsbury’s shares also trade at a premium to historical levels. Its forward P/E ratio is now 13.1 times compared to the 10-year average of 11.8 times. I think investors should consider giving both companies a wide berth.
