Is Now The Time To Dump Tesco PLC And Buy McColl’s Retail Group PLC?

As markets around the world plunge, only a few stocks are escaping the turmoil.

One of the companies that’s rising in a falling market is McColl’s Retail (LSE: MCLS). At time of writing, the company’s shares have jumped just under 6% today, while the wider FTSE 250 has declined 2.5%.

What’s more, McColl’s is the only company in the retail sector that’s pushing higher today. Indeed, many of McColl’s larger peers, such as Tesco (LSE: TSCO), are falling. 

But what makes McColl’s so special? Well, the company has shown over the past year that it can buck wider market trends. While other retailers have reported falling sales and profits as a price war takes hold across the UK retail landscape, McColl’s underlying earnings have continued to push higher.

For the six months ended 31 May 2015, total revenue expanded 3.4% after including the contribution of new store sales. Further, adjusted earnings per share for the period increased 45% to 6.1p, and management hiked the group’s interim dividend payment by 100% to 3.4p. 

Struggling to compete

Unfortunately, to a certain extent, the figures above are highly misleading. Underlying figures show that McColl’s is struggling to compete in the UK’s increasingly competitive retail environment.

For example, during the six months to 31 May 2015, group like-for-like sales declined by 1.9%. Sales in newsagents and standard convenience stores slumped 4.5%, and operating profit before exceptional items ticked lower by 6% to £9.6m. Revenue growth was driven by the opening of new stores. 25 news McColl’s stores were opened during the period. 

And while McColl’s shares may be outperforming those of its larger peer Tesco today, over the past 12 months the two retailers have clocked up similar performances. Specifically, over the past year McColl’s shares have declined by 22% and Tesco’s shares have fallen 26%. Year to date, McColl’s has slumped 19%, compared to Tesco’s 3%. However, these figures exclude dividends.  At present, McColl’s supports a dividend yield of 7.2%, and the payout is covered one-and-a-half times by earnings per share. On the other hand, Tesco’s dividend yield is a paltry 0.3%. 

Changing retail landscape

So, if you’re looking for a defensive dividend play, McColl’s could be the company for you. But, as larger peers like Tesco get their act together and start to adjust to the UK’s new retail landscape, smaller players like McColl’s could struggle. 

Tesco’s actions to entice customers back into its stores are already having an effect. During the 13 weeks ended 30 May 2015, Tesco reported like-for-like volume growth of 1.4%, although sales like-for-like sales fell by 1.3%. Still, this decline was better than many analysts were expecting. The City was expecting a decline of between 1.6% and 3%.

Also, Tesco is using its unrivalled size and scale to out manoeuvre smaller peers. Specifically, the retailer’s banking and international arms are providing a much-needed boost to the bottom line as Tesco’s domestic business struggles. 

Nevertheless, Tesco remains a risky bet at present. The company’s turnaround is still in its early stages and the group’s shares trade at a lofty valuation of 22.7 times forward earnings, which doesn’t leave much room for manoeuvre if things go wrong. McColl’s trades at a more attractive forward P/E of 8.9. 

All in all, McColl’s looks cheap, and the company’s dividend yield is attractive but over the long term, it’s unclear if the company will be able to fight off the competition from larger peers. 

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Rupert Hargreaves owns shares of Tesco. 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.