The UK economy is going from strength to strength and, as such, UK-focused retailers could see an uplift to their profitability in the short to medium term. Therefore, it would be of little surprise for the sector to see an improvement in investor sentiment, thereby making now an excellent time to consider increasing your exposure to major high-street names.
Of course, there are a wide range of options within the UK retail sector and, while they may not be the most popular choice at the moment, I’m bullish on UK supermarkets, notably Morrisons (LSE: MRW). The key reason is that there is considerable turnaround potential, with stocks such as Morrisons offering a very wide margin of safety.
For example, Morrisons currently trades on a price to earnings (P/E) ratio of just 15.5, which is less than the FTSE 100’s P/E ratio of 16. And, while the company is set to see its bottom line rise by just 1% this year, versus a mid to high-single digit growth rate for the wider index, Morrisons is expected to post a rise in earnings of 20% next year, as an improving UK economy, cost cuts and a revamped strategy is due to make a major impact on the company’s earnings. As such, Morrisons trades on a price to earnings growth (PEG) ratio of just 0.7, which indicates that its share price could be too low right now.
While there is scope for further gains elsewhere in the UK retail sector, much of the anticipated improved performance of the UK economy appears to be priced in. For example, bakery chain, Greggs (LSE: GRG), is now forecast to increase its net profit by 17% in the current year, followed by 7% next year. Both of these figures have increased recently, as the outlook for the economy has improved, but Greggs still offers less value than Morrisons, with it having a PEG ratio of 1.4.
Similarly, Next (LSE: NXT) may be an exceptional company with huge customer loyalty and tremendous cash flow, but its growth outlook is not particularly appealing. In fact, it is expected to grow its bottom line by just 5.5% per annum over the next two years and, while its earnings could surprise on the upside, its valuation appears to more than take this into account, with a PEG ratio of 3.1 being relatively high.
Meanwhile, home furnishings company, Dunelm (LSE: DNLM), has surprised many investors in recent years with its resilient performance. For example, Dunelm has increased its net profit by just under 20% per annum during the last five years despite it being a cyclical company. Looking ahead, its performance is set to disappoint somewhat, with mid-single digit growth forecast for the next two years. And, with a PEG ratio of 2.8 versus 0.7 for Morrisons, it appears to be less of an appealing buy.
While the performance of the UK economy should not be taken for granted, it does appear to be on the up. As such, investor sentiment in retailers is likely to improve, but with the valuations of a number of sector incumbents offering little in the way of a margin of safety, Morrisons stands out as a stock with upbeat growth prospects and a relatively appealing valuation. As such, now appears to be a good time to buy a slice of it.
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Peter Stephens owns shares of Morrisons. 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.