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The Risks Of Investing In J Sainsbury plc And WM Morrison Supermarkets PLC

Today I am explaining why Sainsbury’s (LSE: SBRY) and Morrisons (LSE: MRW) could be set for more turmoil at the tills.

Under attack from the top, middle and bottom

The relentless fragmentation of the grocery space continues to hammer revenues in the traditional, mid-tier grocery space, a phenomenon which shows no signs of grinding to a halt.

Latest Kantar Worldpanel statistics showed the till rolls at discounters Aldi and Lidl rise a further 19.3% and 13.6% correspondingly during the 12 weeks to 1 March, while posh grocer Waitrose recorded a 4.9% sales increase. By comparison Sainsbury’s and Morrisons both saw sales tick lower by around half a percent, pushing their market shares to 16.8% and 11%.

But Tesco’s (LSE: TSCO) steady recovery over the past few months is also leading to fears that Sainsbury’s and Morrisons are also losing out as the mid-tier cannibalises itself. Indeed, Tesco saw sales rise 1.1% during the three-month period as its strategy of massive discounting paid off.

Balance sheets take a battering

Due to these revenues woes the country’s largest supermarkets have seen their cash piles receive a pasting, in turn hampering their ability to rectify their tailspin through heavy investment.

Sainsbury’s announced in November that it was slashing capital expenditure to between £500m and £550m per year during the next three years, while Morrisons has vowed to cut capex to £400m this year from £520m in the prior 12 months.

As well, both firms’ weakening balance sheets have raised concerns over the extent of dividends looking ahead. Even though Morrisons said this month that the dividend would not fall below 5p per share this year, given that last year’s payout came out at 13.65p there is likely to be some heavy bloodshed. Meanwhile Sainsbury’s warned in November that the payout for this year is likely to be below fiscal 2014 levels, not a surprise given that it will fix dividend cover at two times earnings for the next three years.

Has convenience blown itself out?

Considering that footfall continues to erode across the UK’s grocery megastores, the convenience and online channels have been viewed as the last growth bastion for Sainsbury’s and its rivals. Indeed, the company plans to open around 100 of its Sainsbury’s Local stores each year looking ahead, it has said.

However, planned convenience store closures by Tesco and Morrisons suggests that growth in this area may have peaked, possibly caused by the high degree of competition in this space. The latter has announced that it will slow the creation of its M Local bases looking ahead, as well as shuttering 23 of these stores during the current year. This follows on from Tesco’s plan to shut around 30 of its smaller stores in the near future.

Should current rumours of slowdown in this sub-category prove true, it will prove extremely difficult for the country’s largest supermarkets to generate sustained earnings growth once again, particularly as the internet shopping space is also suffering the same problem of chronic competitiveness.

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Royston Wild 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.