It’s no secret that the UK supermarket landscape has been well and truly shaken up by the German discounters in recent years. Aldi and Lidl have aggressively captured market share at the expense of the traditional big four supermarkets.
Indeed, a recent Which? survey of nearly 7,000 shoppers concluded that Aldi is now the nation’s most popular supermarket, believe it or not. This is due to the quality of its fresh and own-label food, and its special offers.
However, the UK’s largest supermarket, Tesco (LSE: TSCO), is planning to strike back at the discounters. So what exactly is Tesco planning and how does it affect the investment case?
Tesco’s secret plans
According to an article yesterday in The Guardian, Tesco is working on a ‘secret plan’ to develop a new discount grocery chain. The new offer, which would stock around 3,000 products (vs 25,000 for a Tesco Extra store), would be a separate brand that would match Aldi and Lidl on price, in an effort to stop the migration of customers to the discounters.
So what does this news mean for the shares? Is it time to buy?
To my mind, the news doesn’t change the investment case for Tesco shares – it’s still a stock to be avoided. For starters, previous attempts to launch discount chains by the big four have failed. In 2014, Sainsbury’s launched Netto, a joint venture with Dansk Supermarked Group, in an attempt to challenge Aldi and Lidl. 18 months later, it closed all 16 stores, taking a £30m hit in the process.
Tesco’s valuation and dividend yield also look uninspiring at current levels. With analysts expecting earnings of 10.4p per share for the year ending 25 February, the forward P/E is 19.4. An expected dividend payment of 2.9p per share equates to a yield of just 1.4% at the current share price. As such, Tesco is not a stock I’ll be investing in any time soon.
Cheaper supermarket stock
What about rival J Sainsbury (LSE: SBRY)? Are the investment prospects here any better?
Well, a glance at the company’s metrics does reveal a more attractive picture. Analysts expect earnings of 19.1p per share for the year ended 19 March, which at the current price places the stock on a forward P/E of 12.9. That’s a more reasonable valuation than Tesco’s. Sainsbury’s dividend yield is also more attractive. A forecast payout of 9.8p per share for FY2018 equates to a yield of 4% at the current share price.
The acquisition of Argos also looks as if it could help the company’s prospects. An update in November advised that stores with an Argos were seeing an increase in total sales of 1%-2%. Furthermore, Sainsbury’s has plans to deliver £500m in cost savings over three years starting from 2018/2019.
However, despite these bullish points, I’m still not a buyer of the shares. In my view, the supermarket landscape is likely to remain extremely competitive in coming years. This has implications for profits and dividends. As a result, I’m steering clear of the sector for now.
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Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.