Is Now The Time To Sell Tesco Plc And Buy J Sainsbury plc?

Results at Tesco (LSE: TSCO) may have beaten analyst expectations last week, but that says more about low City expectations than the grocer’s improving prospects, given that operating profits halved from £779m to £354m. Like so many companies on today’s flailing FTSE 100, Tesco has resorted to cost-cutting in a bid to keep the numbers looking good, trimming around £400m of fat from group restructuring and more than 50 store closures.

Chief executive “drastic” Dave Lewis knows his honeymoon period is over but investors are still cutting him some slack. Given the string of disasters that have afflicted Tesco lately, the lack of further bad news such as a profit warning was seen as a plus. It helped investors swallow the news that UK and Ireland operating margins are now a wafer thin 0.8%.

Tesco’s Share Price Soars!

The real shock was to find Tesco’s share price has leapt 15% over the last week. A combination of not-quite-as-bad-as-expected results and the wider surge in market sentiment lifting the stock. Sales volumes are rising, which suggests customers may be creeping back, in the hope that Tesco has learned some hard lessons. 

Further recovery will not be easy. Tesco can’t rely on endless cost-cutting to boost cash flow but boosting margins won’t be easy in today’s deflationary world. The glory days will never return, whatever Tesco does, because we live in a different retail world, thanks to changing family shopping habits, online grocery competition, and the rise of Aldi and Lidl. It will also take a long time to restore the dividend, now forecast to be just 1% in early 2017. Lewis has done a good job but there is only so much he can do, with sectoral winds against him. Trading at a forecast 23.7 times earnings, he has to work hard to justify Tesco’s current pricey valuation.

A Different Taste?

I always felt that J Sainsbury (LSE: SBRY) was unfairly punished by wider market forces. In January last year it was celebrating 36 consecutive quarters of sales growth, an astonishing run that did less for its share price the longer it lasted, only to be hit hard when the record came to an end. But the last 12 months have been kinder, with the share price up a healthy 20% in 12 months, and 7.7% in the last week alone.

The recent second quarter trading statement was heralded as the first outright positive news from a big four supermarket in years. Again, that reflects low expectations, with a rise in total Q2 retail sales of just 0.3%. 

Match That!

Sainsbury’s relatively upmarket positioning has been a blessing rather than the curse it could have been, while the recent Price Match campaign has preserved its position among cash-strapped shoppers. Its decision to reduce promotions and move towards lower everyday prices seems to have chimed with the public mood. Consumers seem content to pay a little more at Sainsbury’s, whereas they aren’t in Tesco.

Investors even get a dividend, although the yield is expected to dip to 3.8%. Trading at a forecast 12 times earnings, Sainsbury’s looks better value than Tesco too. I remain suspicious of the grocery sector, but if the trend towards rising personal incomes continues, Sainsbury’s could still be worth a place in your portfolio. I remain unconvinced about Tesco, though.

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Harvey Jones has no position in any shares mentioned. 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.