Why I would buy Tesco plc instead of Majestic Wine plc following today’s results

Shares in Majestic Wine (LSE: WINE) have slumped by as much as 28% today after it released a profit warning. Although the company has long-term growth potential, things could get worse before they get better. That’s a key reason why I’d rather buy Tesco (LSE: TSCO) than Majestic Wine.

Majestic Wine’s operating profit for the current financial year is now expected to fall below market expectations. There are two key reasons for this. Firstly, Majestic’s commercial division has endured a challenging first part of the year, with resulting in flat growth year-on-year. Furthermore, gross margin achieved on sales has declined by 2%.

Assuming the negative trends in Majestic’s commercial business persist through to the end of the year, the division’s operating profit could be as much as £2m lower than previous guidance. In order to improve its performance, an internal review is now under way but in the near term the commercial division’s future is highly uncertain.

Secondly, Majestic’s Naked Wines USA division has experienced disappointing results from its direct marketing campaign. Despite a test run showing promise, results from the campaign have been worse than expected. This will cause the profitability of the division to be less than expected, with operating profit due to come in around £2m lower than previous guidance.

Clearly, Majestic Wine is enduring a very challenging period. While in the long run the company has growth potential and is likely to turn around its current problems, in the near term things could get worse before they get better as investors digest the new outlook for the company.

More appealing?

As a result, Tesco has significantly greater appeal as an investment. It has already been through a very difficult period that saw profitability come under severe pressure. While its future outlook is uncertain, it has a sound strategy to deliver profit growth and it appears to be working well.

For example, Tesco is forecast to increase its earnings by 137% this year, followed by further growth of 38% next year. This puts it on a price-to-earnings growth (PEG) ratio of just 0.2, which indicates that it offers excellent value for money. Compare this to the outlook for Majestic, which is extremely uncertain and could be the subject of further downgrades, and it’s clear that Tesco offers superior growth potential.

In addition, Tesco is a lower-risk investment than Majestic. Tesco has a size and scale advantage over Majestic and this could prove to be a major competitive advantage over its peers should the difficult outlook for the consumer sector continue. Tesco also has stronger finances, which could be used to boost its growth opportunities through acquisitions. As such, Tesco’s risk/reward ratio is superior to Majestic’s and this makes it a much more enticing buy for the long term.

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Peter Stephens owns shares of Tesco. 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.