There’s no arguing against it, we’ve been through been a dreadful five years for supermarket shares, but the sector has seen mixed fortunes in 2018.
Over five years, J Sainsbury (LSE: SBRY) shares have lost 30% of their value, but a 43% price fall for Tesco (LSE: TSCO) makes that look relatively good. Both have badly underperformed the FTSE 100, which has been flat overall.
The collapse of supermarket shares is squarely down to price competition, with the march of Lidl and Aldi and their lower prices for similar quality products convincing our increasingly squeezed shoppers to shift their allegiance. I, for one, haven’t visited a Tesco, Sainsbury or Morrisons store since two Aldi branches opened within a mile of my home.
From the brink
Through cost-cutting, Tesco has come back from its crisis and is now competing more effectively for market share, and its collapse in profits is being increasingly reversed with decent growth forecasts on the cards for the next couple of years.
Rupert Hargreaves believes that Tesco shares could provide security against the economic hardships likely to come from Brexit, and he’s absolutely right that essentials like food are the things that people simply can’t avoid buying, no matter how tight their belts. New houses, cars, clothes, holidays… they can all wait, but bellies need to be filled.
So I think supermarket shares are likely to have a better year in 2019 than they’ve had in 2018 — and let’s face it, they could hardly have a worse one.
Tesco does have EPS growth forecasts of 13% to 20% supporting its recovery, and the P/E should drop to under 12 by 2020 if forecasts prove accurate. But we’re still looking at a 2018 P/E of over 16, and I can’t help thinking investors will still balk at that until they see forecasts turning into actual earnings.
Show me the cash
Dividend yields are predicted to rise to 3.8% by 2020, but this year we’re only expecting 1.5%. And again, I’d want to see the colour of the money myself before I’d consider buying.
Over at Sainsbury, we’ve got what looks like the opposite situation — a more attractive valuation and dividend yield now, but weaker forecasts. In fact, analysts expect no earnings growth this year or next from Sainsbury, and then only 3% in 2020.
But against that, the shares are currently trading on a more modest P/E of 13, with dividends already set to yield 3.7% this year (rising to 4.1% on 2020 forecasts). Will cautious investors prefer safer returns now to speculative profits later? In the current climate, I think they will. And incidentally, I see the relatively high P/E ratios of Tesco and Sainsbury’s compared to more risky stocks as further evidence of a current flight to safety.
As Roland Head has pointed out, the Sainsbury’s acquisition of Argos has helped solve its problem of excess store capacity, though at the expense of margins. But that takeover will look like small change should the planned merger of Sainsbury’s and Asda go ahead. It’s still up on the air, but a combination of the two should seriously enhance purchasing power — and Sainsbury’s shareholders could do very well out of it.
I think the bearish sell-off in other sectors will provide better buying opportunities in 2019 than either of these, but I think it could be a good year for supermarkets.
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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. 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.