Kingfisher plc vs Tesco PLC: Which Distressed Retailer Should You Buy?

b&qB&Q owner Kingfisher (LSE: KGF) (NASDAQOTH: KGFHY.US) surprised investors this morning, reporting a 1.8% fall in second-quarter like-for-like sales. By 10.45am, the firm’s shares were down by 8%, suggesting that investors are pricing in another profit warning later this year.

Of course, Kingfisher isn’t the only struggling retailer in the FTSE 100.

Supermarket giant Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) issued another profit warning earlier this week, and although their businesses are different, I’m beginning to see a lot of similarities between these two firms — both of which are down by around 20% so far in 2014.

1. Profitability

Both Kingfisher and Tesco are struggling with flagging sales and costly large store networks.

Both companies have little choice but to cut prices to try and stimulate sales. Kingfisher’s chief executive, Sir Ian Cheshire, said today that the firm would be “accelerating our self-help margin and cost initiatives” — management speak for slashing prices and cutting costs.

At Tesco, shareholders will have to wait until October to see if their new chief executive, Dave Lewis, will decide to engage in a full-scale price war.

Kingfisher’s current operating margin of 6.8% is significantly higher than Tesco’s, at 4.1%, but averaged over the last five years, the figures are closer, at 6.7% and 5.4% respectively.

In my view, neither firm has yet reached the bottom of the current price-cutting cycle.

2. Valuation

Although Tesco’s biggest business is its UK division, both retailers are facing similar problems: they are being forced to cut prices to try and stimulate sales across large store networks.

Interestingly, both companies now have very similar valuations. Kingfisher currently trades on a 2015 forecast P/E of 12.7, while Tesco trades on a debt-adjusted 2015 forecast P/E of 14.

3. What’s next?

The short-term outlook seems uncertain for both Kingfisher and Tesco. If Kingfisher’s soft trading continues through the summer, then it could be forced to issue another profit warning.

Similarly, Tesco’s new boss, Unilever’s Dave Lewis, is likely to do a kitchen sink job in his first update to the market, throwing in all the bad news possible, so that it can be blamed on his predecessor.

My suspicion is that the share prices of both companies will fall further before they return to growth. Personally, I would buy Kingfisher if the share price fell below 280p, and I have recently topped up with Tesco shares, which I believe are cheap enough already.

However, if I'm honest, I think there are better buys than both Kingfisher and Tesco in today's market. I'm particularly interested in two of the firms highlighted in the Fool's latest wealth report, "The Motley Fool's Three Shares To Beat Property".

One of these companies currently trades on a forecast P/E of just 10, but has strong profit margins and a dividend yield of more than 4%. The second company I like isn't so cheap, but has fantastic long-term growth potential.

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Roland Head owns shares in Unilever and Tesco. The Motley Fool owns shares of Tesco and Unilever.