Why J Sainsbury plc Is A Buy And Tesco plc Is A Sell For Me

What is shopping to you? Is it fun? Or a chore?

I actually enjoy shopping. It’s an excuse to take my son out of the house, and it’s fun to browse the aisles to find a tasty ready meal or that perfect bottle of wine.

Sainsbury’s, moving both upmarket and downmarket

I think shoppers are divided between those who find their visit to the local supermarket a chore where they try to save as much money as they can, and those whose main concern is whether they should buy the beef with udon noodles or the Thai red curry.

I often talk about this being a low-cost, China-centric world. This means there are lots of cheap and cheerful products, allowing you to spend the very minimum and still have a reasonable standard of living.

However, it also means that high-quality, value-added (even luxury) products are cheaper and more plentiful than they’ve ever been. With the massive production capacity of China, it can cater amply for both markets.

The thing about shopping at Sainsbury’s (LSE: SBRY) is that it’s increasingly becoming like shopping at Marks & Spencer and Waitrose. It’s an enjoyable experience where you think about more than the bottom line on your till receipt. The supermarket is full of what you might term affordable luxuries.

Seen in this light, I can understand the point of the company’s bid for the Argos arm of Home Retail Group. At first, it seemed a little incongruous, after all Argos is low cost to the core. But what if you could make Argos more like Sainsburys or Marks & Spencer? What if it could sell both the cheap and cheerful products that Argos is famed for, and also start selling products that are just that little bit more interesting, more carefully-crafted, more fun? These products would increase margins, and move the store upmarket. Plus cross-selling opportunities would mean Sainsbury’s could cater for more of the value market consumers who traditionally shop at Tesco (LSE: TSCO).

Tesco, squeezed by price-conscious customers

This clever strategy is the main reason why Sainsbury’s is the only one of the big supermarkets that’s maintaining and growing its profitability in the face of fierce competition from Aldi and Lidl.

By contrast, most shoppers at Tesco are thinking about squeezing as much value from their weekly shop as they can. If Tesco can’t beat the prices of rivals such as Asda and Morrisons, then people will buy their groceries elsewhere. To stop this exodus, the company has had to cut prices, and this has led to falling profitability.

That’s why Tesco is in a far more difficult situation, as it’s being assailed at both the low and high ends. But it has, at least, arrested the fall in sales. I think Tesco is that little bit more plush than it used to be, with cafés and restaurants. But it’s no longer the money-making machine it once was. A forecast 2016 P/E ratio of 35.07, with a dividend yield of just 0.69%, looks expensive. This compares with a 2016 P/E ratio of 10.88 and a dividend yield of 4.56% for Sainsbury’s.

It wasn’t that long ago that Sainsbury’s was the whipping boy, while Tesco was carrying all before it. But today Sainsbury’s looks like a promising high-yield play, while Tesco is one (still) to avoid.

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Prabhat Sakya 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.