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Why I’d Buy J Sainsbury plc And McColl’s Retail Group PLC, But Would Sell Ocado Group PLC

The UK supermarket sector is going through one of the most significant changes in its history, with there being a major shift in shoppers’ habits. For example, the large, out-of-town hypermarkets that were popular for so many years have seen sales decline, as shoppers have begun to favour convenience stores and online grocery shopping. This trend shows little sign of abating, with the major supermarkets mothballing plans to build larger stores and instead focusing on online and convenience store development.

Sector Opportunities

On the face of it, then, a traditional supermarket such as Sainsbury’s (LSE: SBRY) (NASDAQOTH: JSAIY.US) may not hold much appeal. After all, it has a vast estate of large out-of-town stores that are struggling to post any kind of positive growth numbers. And, while it does have increasing exposure to the online and convenience store spaces, many investors may decide that investing elsewhere is a better option.

Online Only

The problem, though, is that the only listed pure play online grocer is Ocado (LSE: OCDO). Of course, it has a bright long term future as it is set to benefit from having no physical stores to slow its growth rate and a tailwind from more shoppers switching to home delivery. However, much of its future growth appears to be priced in to its current valuation, with Ocado’s shares currently changing hands on a price to earnings (P/E) ratio of 148. As such, even if it posts stunning growth over the long term, the market appears to be pricing this in and, as such, its share price may not rise as much as is currently expected.

Convenience Stores

When it comes to convenience stores, however, there is a much more favourable opportunity for investors. That opportunity is McColl’s (LSE: MCLS), which owns around 1300 stores across the UK and, unlike Sainsbury’s, posted strong growth in its bottom line last year, with its earnings rising by a very impressive 24%. Despite this, McColl’s offers excellent value for money, with its shares currently trading on a P/E ratio of 10.7 and, with convenience stores becoming increasingly popular, an upward rerating to McColl’s valuation is very possible.

Looking Ahead

Clearly, Sainsbury’s is likely to be held back by its large stores. However, the company has introduced a sensible pricing strategy that should expand its margins over the medium to long term and, with its online and convenience offerings continuing to grow in popularity, its bottom line is expected to return to growth in financial year 2017. And, with its shares trading on a P/E ratio of just 12.7, it appears to offer excellent value for money and, as with McColl’s, seems to be worth buying right now.

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Peter Stephens owns shares of Sainsbury (J). The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.