Have Tesco PLC, WM Morrison Supermarkets plc & J Sainsbury plc Topped Out Already?

The key question now for such food retailers such as Tesco (LSE: TSCO), Morrisons (LSE: SBRY) and Sainsbury’s (LSE: SBRY) is whether their valuations will rally to the end of 2015 and beyond. I am moderately bullish about Tesco and Morrisons, but I believe Sainsbury’s will be the laggard. Here’s why.

A Lower Payout & Write-Downs Are Good News For Morrisons

Morrisons recently showed how financial accounts should be managed. It took a large £1.3bn write-down on the value of its properties, and that was a good thing. The leaner the balance sheet, the better — but the profit and loss statement equally deserves lots of attention.  

I have always seen 200p as a key level for Morrisons stock, based on the market value of its assets, and a lower payout ratio going forward is important, too, because it will be difficult for new chief executive David Potts to restore a decent level of core profitability in only a few quarters. 

The stock was flat two weeks ago when results came out, and was virtually unchanged last week as investors were not impressed with its latest trading update. Yet such a market response was good news, in my view. As everybody knows, it will take time for Morrisons to get its operations back on track and particular attention must be devoted to its online business.

In this context, analysts argue that Mr Potts may decide to exit the partnership with Ocado. Well, I think Ocado could be an ideal target for Morrisons, particularly if the shares of the £2.2bn delivery company keep on trading below 400p. The strategic merits aside, such a tie-up wouldn’t make much sense economically, however, while it would be a stretch financially. 

Tesco & Sainsbury’s: Which One Should You Choose? 

Tesco posted its strongest revenues growth in one and a half years, it emerged earlier this month, when its shares lost almost 4% of value in one day, underperforming the FTSE 100 by almost two full percentage points. Why was that? 

Investors took profits, and there is nothing unusual in it: Tesco is up almost 40% over the last three months alone. 

Tesco has been writing down the value of its assets for some time now, and in a way its restructuring is not too different from that of a troubled retail bank that also must preserve its core level of profitability. Many banks have written down assets in recent years, and their shares have benefited from huge write-downs.

I’d expect property write-downs of at least £700m this year, which is a conservative estimate, and may come on top of additional goodwill write-offs. This is a lengthy process, but the grocer’s debt maturity profile is sound and its massive infrastructure network could shrink via disposals, thus releasing value.

In fact, recent trends show that the operations may have bottomed out in the second fiscal quarter of last year. If I am right, some 30p to 50p could be added to its current valuation of 244p to the end of the year. 

While Tesco and Morrisons seem poised to rise, Sainsbury’s may well continue to find it difficult to create shareholder value. Sainsbury’s is the laggard: sales at Morrisons are slowly rising, but Sainsbury’s revenues are still down, based on comparable figures, and it looks a lot like management has not understood how serious the situation is. The financials released last week confirmed recent trends: the retailer posted its fifth straight quarterly fall in sales. If thing do not improve materially, its dividend policy may soon come under scrutiny, and large write-downs in its property portfolio will likely ensue in my opinion. 

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Alessandro Pasetti 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.