Rising sales at Wm Morrison Supermarkets plc spell good news for Tesco plc

Until recently, embattled supermarket Morrisons (LSE: MRW) looked headed for the remainder bin. It was retrenching on every front, with sales slipping, customers fleeing to Aldi and Lidl, attempts to break out of its northern heartlands thwarted, its chain of M convenience stores sinking.

Wish I could be like David Potts

What a difference a year makes. The company’s share price is up 30% over the last 12 months and this week it delivered a fourth consecutive quarter of growth. Chief executive David Potts is taking it all in his stride, talking up his plans to make the supermarket even more competitive and improve the shopping trip. However, I would think twice about investing now. It trades at 28.75 times earnings and yields just 2.24%, which looks more like a high-growth tech stock than a play on the stodgy grocery sector.

I reckon Tesco (LSE: TSCO) is the one to watch. It’s trailing Morrisons in the recovery stakes but that may work in its favour, as it has more catching up to do. The share price is up 35% in three months and prospective investors might want to place their bets soon or quit the field, before all the value is gone.

Dave the rave

Three years ago I wrote that I was sweeping all the supermarkets in my portfolio and I remain sceptical. Aldi and Lidl continue to look menacing. So does Brexit – if it happens – which will have all sorts of unknowable effects on import costs, food prices, customer salaries and sentiment

However, Tesco boss Dave Lewis has aggressively tackled many of the problems afflicting Tesco, which were mostly down to scale and arrogance, such as its fancy HQ, fleet of private jets and heady plans for global domination. The supermarket has now posted three consecutive quarters of sales growth, only one behind Morrisons and Christmas is still to come.

Deficit disorder

Tesco’s numbers are a mixed basket. Group operating margins are thinly sliced at just 1.9%, and management’s ambitions of hiking these to 3.5%-4% by 2019/20 could prove challenging, given consumer and press alertness to shops passing on food price inflation. There’s no dividend and with the grocery price war set to rage on, repairing that will take time. The yield is a forecast 1.2% for the year to 28 February 2018, but even that could prove sticky.

Tesco is on a whopping valuation of 61 times earnings, but 167% forecast earnings per share growth in the year to 28 February 2017 should shrink that to 28%. With forecast EPS growth of 33% after that, the valuation should slowly come into line. Its recovery remains a work in progress, work that must be carried out under the shadow of its massive pension deficit, although the recent increase in bond yields, if it continues, might help a little.

Tesco still boasts 28.4% market share, well ahead of its nearest rival Sainsbury’s at 16.8%, according to Kantar WorldPanel. That gives it the benefit of economies of scale, but also makes it a juicy target for its rivals. Tesco, like Morrisons, is out of the remainder bin but I will still hesitate to take it to the till.

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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.