Why J Sainsbury plc looks like a better buy than Tesco plc!

Today I’ll be taking a closer look at the UK’s two largest supermarket chains, Tesco and Sainsbury’s. Both have been under pressure in recent years, losing market share to no-frills rivals like Aldi and Lidl. Share prices have plummeted as a result, but I believe Sainsbury’s could be a better long-term recovery play than its larger rival. Here’s why.

Too soon

The last few years have been tough to watch for long-term investors in the UK’s largest retailer, Tesco (LSE: TSCO), sliding from pre-tax profits of over £4bn in fiscal 2012 to the record-breaking loss of £6.4bn reported in 2015. Underlying earnings per share plunged from 40.31p to just 9.42p over the same period. Shares in the FTSE 100 retailer have followed suit, falling from 411p to 158p over the last five years. In April the company announced a return to profit for the year to February, but sales were down on the previous year, and earnings had fallen again to 3.42p per share.

So is this a bargain waiting to be snapped up, or is this the new norm for the Tesco share price? Well, brokers seem to suggest that Tesco is poised for a comeback, with market consensus pointing to an upturn in revenues and profits over the next couple of years. Indeed, analysts have estimated a staggering 140% rise in earnings this year, followed by a further 39% improvement for the year to February 2018, bringing the price-to-earnings ratio down to 17 from the 54 recorded at the end of the last reporting period.

Frankly, I find these estimates difficult to digest. Sure, management is taking steps to regain its competitiveness in the home market and strengthen its balance sheet, but I believe fierce competition from rivals will mean margins will continue to be squeezed, and it may be too optimistic to expect Tesco to return to past glories any time soon.

Robust rival

Like its bigger rival, Sainsbury’s (LSE: SBRY) has also faced challenges in recent years, with its shares falling from 2013 highs of 414p to current levels around 240p. But the company’s fundamentals have been more robust than those of Tesco. Revenues are slightly higher than five years ago, and earnings are down from 28.1p per share to 24.2p over the same period, nowhere near as dramatic as Tesco’s decline.

The grocer is expected to post a 9% drop in earnings this year to £401m, with a 2% rebound to £408m pencilled-in for FY2018, leaving the shares trading on just 11 times forecast earnings for the year to March 2018. But I don’t believe the shares are as cheap as they seem given the weak growth outlook. However, the picture improves if investors look to the generous dividend payouts, with yields forecast at well over 4% for the next two years, and covered twice by earnings. For me Sainsbury’s remains the pick of the London-listed supermarkets.

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Bilaal Mohamed 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.