The new grocery price war could destroy the supermarkets

It is some months since I studied the supermarket sector in any depth and I’m sad to report on my return that things haven’t improved, and the big grocers continue to serve thin gruel to investors.

Shop horror

Over the last month, Tesco (LSE: TSCO) has continued its long-term decline with the share price falling more than 12%. WM Morrison (LSE: MRW) and J Sainsbury (LSE: SBRY) have also fallen, albeit with a slightly slower drop of just over 5%. Brexit has become the catch-all excuse for any company with a bad story to tell but in this case the supermarkets have a point.

The shock referendum result fuelled the biggest drop in consumer confidence in more than 26 years in July, according to market researcher GfK, with shoppers bracing themselves for further erosion of their spending power as the weaker pound drives up the cost of imported goods and ingredients. Brexit isn’t the only factor behind the 1.1% drop in sales in the four weeks to 17 July, the worst performance in two years, as measured by Kantar Wordpanel. The disappointing British summer has also hit revenues, with rain and wind dampening shoppers’ appetites.

This means war

Now Morrisons is throwing down the gauntlet to its rivals by unleashing a new price war as it looks to blow shoppers out of their post-referendum malaise. It plans to cut the price of more than 1,000 products by an average of 18% in a bid to lure them away from mighty discounters Aldi and Lidl, which saw sales rise 11% and 12.5% respectively in the three months to 17 July, lifting their market share to 6.2% and 4.5%. Fast-growing upmarket rival Waitress and Co-op’s small local stores are also nibbling away at Tesco’s, Sainsbury’s and Morrisons’ market shares.

Price cuts will help Morrisons shoppers, but I can’t see that they’ll do much for its profits or share price, and they’ll also inflict further damage on Tesco and Sainsbury’s, especially if they’re forced to join in the price-slashing battle. All is not lost, Tesco’s earnings per share (EPS) are forecast to grow 133% in the year ending 28 February 2017, reducing its valuation from today’s 45 times earnings to a still pricey 24 times. This offers some relief following five years of negative EPS (double-digit negatives in four of those years, mark you). Tesco’s market share is falling but at the slowest rate for two years, and it remains the grocery sector big boy with 28.3% of sales.

Not so supermarkets

Sainsbury’s has a share of 16.3% but is also declining slowly, although trading at 9.19 times earnings and yielding 5.43% it remains my pick of this shop-soiled trio. Morrisons has done better than I would have expected in recent months and while sales continue to slip it still boasts 10.7% market share. However, trading at 23.05 times earnings and yielding 2.78%, I can think of a dozen different companies I would rather invest in today.

Tesco, Sainsbury’s and Morrisons are struggling to shake off the spectre of long-term decline, and a fresh price war could wound them all. I will expend my ammunition elsewhere.

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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.