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Why The Tipsters Like Tesco PLC Better Than J Sainsbury plc And WM Morrison Supermarkets PLC

It’s been a long time since the City’s analysts have been bullish over our FTSE 100 supermarkets, but the tide could finally be turning — they’re starting to tip Tesco (LSE: TSCO), at least.

All three of the big ones have seen their share prices recover in recent months, with Tesco up almost 50% since its mid-December low, J Sainsbury (LSE: SBRY) up 21% since an October dip, and Morrisons (LSE: MRW) up 29% over a similar period.

Buy Tesco?

But Tesco is the only one the pundits are urging us to Buy. Admittedly, 10 of the 21 surveyed are sat on a Hold recommendation, but of the others we have a seven to four split in favour of the bulls. Things are less rosy for Sainsbury’s, with six against four opining that we should Sell and eight on the fence. And for Morrisons, things are looking the worst of all — eight urging us to Dump the stock, with only four bullish and five not making up their mind. Why the difference of opinion?

I think it’s fairly clear, and it’s to do with dividends. Tesco’s was famously pared to the bone, and that was exactly the right thing to do — the only alternative would have been to pretend that Lidl and Aldi were going to go away and that higher margins were just around the corner.

Morrisons held out stubbornly, despite plunging earnings and the escalating price wars. But a 6.8% dividend yield that would not even be covered by earnings? Really? Now that Morrisons has a new management team in place with David Potts, former director of Tesco, at the helm, a dividend cut is widely expected.

Sainsbury’s is the dark horse here, as it is apparently sticking to its plans to pay out 50% of underlying earnings. But with earning predicted to fall for the next two years, we’d still see the dividend dropping. And I really don’t know how long that 50% target can be kept up — even dividend yields around 4% could be under a squeeze as margins tighten.

Price targets realistic?

January brokers’ price targets suggested around 200p for Tesco, which is really not very encouraging for a share already trading at 245p. But they tend to be short-term targets, and in that context I can understand the mooted levels — Tesco shares are on a forward P/E of over 20 right now. But with an earnings recovery looking close, those with a five-year horizon could see a bargain in Tesco.

Targets for Morrisons aren’t much better, coming in around the current price of 195p. But in this case I think that’s optimistic and a dividend cut might well reverse the current price recovery. Longer term things might look better, but I think we’d need to see where the dividend goes first.

And again at Sainsbury’s, targets suggest 250p to 275p and the shares currently change hands at 272p. Sainsbury’s shares trade on the lowest P/E of the three, of only around 12 for 2015 forecasts, but I’m not convinced there isn’t hardship coming in the medium term.

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Alan Oscroft 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.