Why I’d Buy J Sainsbury plc, Marks And Spencer Group Plc And Sports Direct International Plc, But Would Sell ASOS plc And Greggs plc

2015 has been a major turning point for the UK retail sector. Although it has been a rather gradual process, and is not yet complete, retailers are seeing the green shoots of recovery emerge as the market looks forward to improved performance in 2016 and beyond.

A key reason for this is rising disposable incomes in real terms, with UK shoppers benefitting from wage growth that is higher than inflation for the first time since the start of the credit crunch. And, while the potential for a rise in interest rates could hold consumer demand back somewhat, the likelihood of a rapid tightening in monetary policy seems to be rather slim.

A shrewd move

Therefore, buying the likes of Sainsbury’s (LSE: SBRY), M&S (LSE: MKS) and Sports Direct (LSE: SPD) could be a shrewd move. In the case of Sainsbury’s, its bottom line is forecast to flat line next year, which would represent a major improvement on two years of falling net profit. Furthermore, Sainsbury’s has changed its pricing strategy to accommodate the rising income levels of its customers, and is now focusing less on price and more on the quality and choice of its own brands.

So, while its “brand match” pricing campaign was successful, it is now more limited and Sainsbury’s is seeking to generate increased sales from higher margin, own brand goods in future. With its shares trading on a price to earnings (P/E) ratio of 12.3 there is substantial upward re-rating potential.

Similarly, M&S is gradually seeing a positive impact from its store refreshes, attempts to improve the efficiency of its supply chain and also a developing online presence. Next year its earnings are forecast to rise by 9%, which puts it on a relatively appealing price to earnings growth (PEG) ratio of 1.5. And, with M&S having a forward yield of 3.9%, it remains an attractive income stock, too. That’s especially the case since M&S has a dividend which is covered 1.9 times by profit and therefore appears to be highly sustainable.

Meanwhile, Sports Direct has benefitted hugely from more price conscious consumers as its business has grown rapidly during the credit crunch. Looking ahead, it appears to be in a strong position to continue this growth, with its own brands offering the scope for price rises in response to improved consumer confidence and, as such, Sports Direct is due to post an increase in earnings of 11% this year and a further 16% next year. Trading on a PEG ratio of 0.9, it also has great appeal even if the economy endures a challenging period as interest rates rise.

Fully valued

However, the likes of ASOS (LSE: ASOS) and Greggs (LSE: GRG) may not be such strong investments at the present time. Both are high quality businesses that have endured a tough time in recent years but which now appear to be on the up, with new strategies focussing on their core markets set to allow them to record impressive profit growth.

The problem for investors, though, is that both stocks appear to be fully valued at the present time, even after their growth prospects are taken into account. For example, ASOS has a PEG ratio of 2.5, while Greggs’ is even higher at 3.3. Therefore, even if they do record improved financial performance, the market appears to have already taken this into consideration. And, if their growth rates do disappoint, then their shares could come under severe pressure. As such, the likes of Sainsbury’s, M&S and Sports Direct appear to be better long term buys.

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Peter Stephens owns shares of Marks & Spencer Group and Sainsbury (J). The Motley Fool UK owns shares of and has recommended ASOS. The Motley Fool UK has recommended Sports Direct International. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.