Why Wm Morrison Supermarkets plc could be a better buy than J Sainsbury plc

Shares in Wm Morrison Supermarkets (LSE: MRW) rose by 2% this morning, after the firm reported a second consecutive quarter of like-for-like sales growth.

Morrison’s like-for-like sales rose by 0.7% in the three months to 1 May, despite price cuts pushing down prices by an average of 2.6%.

The company’s figures show that customers are making more, smaller transactions. Like-for-like transaction numbers rose by 3.1% during the quarter, but the average number of items per basket fell by 2.8%. One reason for this is the popularity of Morrison’s Food to Go snack food range, sales of which have risen by 17% over the last year.

A single-minded focus on being a well-run food producer and retailer seems to be paying off for Morrisons. The shares have risen by almost 30% so far in 2016, and last year’s results showed a strong financial performance. Morrisons’ free cash flow generation of £854m — almost 20% of the firm’s market cap — was a particular highlight.

The group’s recent deal to supply food to Amazon is also good news, as it should enable Morrisons to increase volumes in its food production business with minimal investment.

What about Sainsbury?

The market’s warm reception to Morrisons’ trading update is a sharp contrast to the cold shoulder given to J Sainsbury (LSE: SBRY) after its results were published on Wednesday. The company’s share price fell by 7% after chief executive Mike Coupe warned of tough market conditions for the “foreseeable future”.

Although Sainsbury’s full-year results weren’t bad — like-for-like sales only fell by 0.9% — City analysts are cautious on the outlook for Sainsbury. The group’s underlying profits fell by almost 14% and the dividend was cut by 8.3%. Consensus forecasts for the year ahead suggest that earnings per share could fall further. That’s a sharp contrast to Morrisons, where earnings per share are expected to rise by about 10% in 2016/17 and 2017/18.

Will Argos boost profits?

Whereas Morrisons is focusing all of its attention on food retailing, Sainsbury’s is keen to diversify into general retail. The group has made much of the success of its Tu clothing range and has just agreed a £1.4bn deal to buy Argos.

The Argos deal makes sense on paper, but it will take a couple of years before we see whether the promised benefits can be delivered. Supermarkets have a fairly poor record when it comes to diversifying.

What do the numbers say?

One area where Sainsbury scores more highly is in terms of value. Sainsbury trades on a trailing P/E of about 11 and a 2017 forecast P/E of 12.4. The equivalent figures for Morrisons are 24 and 18.5.

Even after this year’s dividend cut, Sainsbury’s also offers a higher yield.  The firm’s 2015/16 payout of 12.1p per share equates to a yield of 4.6% at the current share price. Morrisons’ 2.6% trailing yield seems poor in comparison.

I’d normally argue that the cheaper stock — Sainsbury — is the better buy. But I’ve been impressed by Morrisons’ consistent progress and feel that the outlook for Sainsbury’s is much more uncertain.

For that reason, I’m going to hold on to my shares in Morrisons for a bit longer yet, despite the temptation to lock in a profit.

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Roland Head owns shares of Wm Morrison Supermarkets. 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.