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Why You Need To Look At Tesco PLC And J Sainsbury plc Before 2015 Gets Under Way

I could give you the facts and figures about Britain’s supermarkets right up front, but I risk boring you to tears. You could probably find the same figures yourself without too much trouble. Instead, I want to give you a little narrative — a little story that helps explain the UK’s supermarkets. This Fool believes that from there, you will have a better idea about which (if any) supermarket chain you want to financially back in 2015.

The VERY big picture

Things were going just swimmingly in 2007. The economy was in good shape (or so we thought) and the FTSE 100 had been on the up-and-up since 2002. It all started to go pear-shaped in 2008. The FTSE 100 started to fall sharply and the UK economy began its slide into what would be a deep recession. Britons lost their jobs and the ones who managed to keep them found out the hard way that, unless your wages keep pace with inflation, it’s all a bit grim (living standards fall). German discounters Aldi and Lidl saw their opportunity and went for it.

For the first time in decades, Britons were willing to forgo ‘plush’ grocery store layouts, mid-priced food, and plastic shopping bags, in favour of a “cheap” shopping experience. The food was essentially the same, the service was basic, but the prices were down… way down.

The British economy has since recovered, but it has been at the expense of the consumer. That is, wages are still relatively low and budgets are tight. Tesco (LSE: TSCO), J Sainsbury (LSE: SBRY)  and WM Morrison Supermarkets have since watched some of their ‘loyal’ customers disappear to the other, discount stores.

Breaking it down

The figures are actually quite brutal.

After a series of stuff-ups (to put it lightly), it was revealed in December that Tesco would produce earnings in 2014 of £1.4 billion (down from £2 billion in 2013). Last month, J Sainsbury announced a pre-tax loss of £290 million in the previous six months.

What’s a supermarket to do?

J Sainsbury has warned investors that business will be tight for the foreseeable future but says the supermarket needs to improve the quality of its products and needs to cut prices. In fact, it’s sacrificing £150 million pounds in order to achieve this. So will that strategy work? Well, J Sainsbury gets half-marks. Improving the quality of its products is vital, but it should charge more for those products, not less. You see, Waitrose is one of the few grocery stores (outside of the majors) to have gained market share in 2014. That’s where I see an opportunity for J Sainsbury. Others have gone before J Sainsbury in cutting prices and failed. Morrisons, for example, cut prices to compete directly with Aldi and Lidl but City analysts say so far that hasn’t worked. In fact few, if any of the strategies of the majors have worked to date.

Just to be crystal clear, according to Kantas Worldpanel, Tesco has competed on price and deals and as a result has lost 2.7% market share. J Sainsbury has done the same and lost 1.8% market share. Waitrose stuck to its guns in 2014 and gained 6% market share. Aldi and Lidl are laughing all the way to the bank, up 18% and 22% respectively. Impressively, analysts say that Aldi and Lidl, who already have a combined market share of around 8%, may double this in the coming year.

Future uncertain

The discounters may well continue to compete on price, but it has to be remembered that that is really all they have to compete with. It’s been shown over and over again that consumers prefer cut-prices rather than deals and gimmicks. Given that, I’ll be watching with great interest to see if the new cut-price move by One Stop (owned by Tesco) could influence Tesco’s strategy. Tesco may need to do what OPEC is doing with the oil price — drop prices dramatically to flush out the competition. The company would need to trim its size though for that to have any chance of working.

J Sainsbury, on the other hand, must take note of Waitrose. This Fool has a few ideas for the grocer: downsize, significantly increase food product quality, and raise prices. Why not? The future’s looking shaky for the grocer in any case.

I can definitely remember a time when you didn't even have to think about the supermarkets before throwing wads of cash at them. After all they are "consumer staples", or 'safe' stocks. That has since changed. One or two supermarkets may very well emerge in 2015 as being exceptional value, but if you're after more certainty in your portfolio, I want you to consider looking at The Fool's 5 Shares To Retire On.

The usual sectors are covered: consumer/household goods; utilities; and healthcare. Most of the stocks in this report aren't very exciting, but by George you can depend on them. So why not give the report a read? A lot of work has gone into making sure they are the right stocks for someone looking to retire with some peace of mind. Simply click here for your copy. There's no obligation to do anything further and it's completely FREE.

David Taylor 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.