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Are Tesco PLC, WM Morrison Supermarkets PLC And J Sainsbury plc Value Traps Or Value Plays?

Value investors love searching in the market’s rubbish bin for the best deals. A list of the stocks currently trading at a 52-week lows is a great place to start when looking for companies that have lost favour with investors. 

Tesco (LSE: TSCO)Morrison (LSE: MRW) and Sainsbury’s (LSE: SBRY) have made several appearances on the 52-week lows list during the past year. But the key question is, are these retailers value plays or value traps? 

Value trap

Value traps are difficult to spot and finding them isn’t an exact science. More often than not, investors find themselves being sucked into a value trap without realising it. 

Nevertheless, most value traps have key three common traits — and by avoiding companies that display these characteristics, you can increase your chances of avoiding these traps. 

Still, as mentioned above finding value traps isn’t an exact science, and while it’s possible to improve your chances of avoiding traps, it’s not possible to avoid them entirely.

Secular decline 

The first common characteristic of value traps is that of secular decline. Simply put, the company may be serving a market that no longer exists in the way it used to.

No matter how good the company is at what it does, if the sector itself is contracting, the firm will struggle to instigate a turnaround. It may also be the case that the company needs to change its business model. 

Now, here’s the thing, all three retailers — Sainsbury’s, Tesco and Morrisons — are struggling to instigate a turnaround in an industry that’s currently undergoing a huge structural change. The rise of the discounters has forced all three retailers to rethink their strategy. 

That said, the food retail sector as a whole is unlikely to become irrelevant any time soon. Tesco, Sainsbury’s and Morrisons are still relevant, and serve a huge market. 

Destroying value 

The second most common trait of value traps is the destruction of value. In other words, investors need to ask if the company’s management has destroyed shareholder value by overpaying for acquisitions and misallocating capital?

Unfortunately, all three of the retailers are guilty of destroying value. Tesco, Sainsbury’s and Morrisons have all announced hefty property writedowns this year, wiping out billions in shareholder equity.

Tesco’s £7bn property writedown helped contribute to the company’s £6.4bn full-year 2014/2015 loss and Sainsbury’s near £800m writedown resulted in the company reporting its first full-year loss for a decade. Also, during the past month Morrison has announced a £30m loss on the sale of its convenience store portfolio. 

Cost of capital 

The third and final most common trait of value traps is a low return on capital invested. Put simply, if a company continuously earns a lower return on invested capital (equity and debt invested in the business) than the group’s cost of capital (debt interest costs), it deserves to trade below book value. 

Here are the key figures for each company. 

Company 

Tesco

Sainsbury’s

Morrison

3-yr Average ROIC

-5.9%

5.5%

5.8%

Cost of Capital Est. 

6.8%

6.6%

9.0%

Current P/B 

2.0

0.8

1.0

Based on these figures, all three of the retailers any deserves to trade below book value as they are destroying value for shareholders.

Overall, Tesco, Morrisons and Sainsbury’s all look like value traps to me.

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Rupert Hargreaves owns shares of Tesco. 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.