As the year draws to a close, I decided to take a sentimental look at some of my old stock picks from the start of the year, and this one leapt out from January. Why I would sell the Sainsbury’s share price today and buy Tesco.
Happily, that proved to be a good call, because Sainsbury’s (LSE: SBRY) has seen its share price fall by 27% in the last year, while Tesco (LSE: TSCO) has shot up in the opposite direction, climbing 20%.
Both started the year in a bad place, with the Sainsbury’s share price down 17% over five years, and Tesco down 30%, as they wilted under the Aldi and Lidl onslaught. I favoured Tesco because it boasted superior earnings growth, operating margins and return on capital employed. I have also been impressed by Dave Lewis’s energetic turnaround plan since joining Tesco in 2014, although I also admired Sainsbury’s boss Mike Coupe’s £1.4bn Argos acquisition, which appears to have paid off so far.
Going head to head
What I couldn’t know at the time was that the Competition & Markets Authority would block Coupe’s bid to merge Sainsbury’s with Asda, although I knew it was a risk, given that the new group would have a total market share of more than 30%. It was a step too far for Coupe, and Sainsbury’s is now searching for a replacement. So would I still favour Tesco over Sainsbury’s today?
Tesco is by far the bigger operation now, with a market-cap of around £24bn. I was surprised to see how far Sainsbury’s has shrunk, as it had now dipped below £5bn. Perhaps inevitably, given recent underperformance, Sainsbury’s is cheaper trading at 11.2 times forward earnings, but Tesco isn’t that much more expensive at 13.6 times.
Going for growth
The best reason for buying Sainsbury’s is the yield, which now stands at a forecast 4.8%, with cover of 1.8. Tesco is still in the process of restoring its dividend, so today’s 3.5% payout looks disappointing, although cover of 2.1 gives scope for further growth.
Operating margins of 2% at Sainsbury’s are lower than Tesco’s 3.2%. The difference in return on capital employed is cavernous by comparison, 3.2% at Sainsbury’s, against 13% at Tesco.
The earnings are the real clincher. Sainsbury’s is in a spiral, with earnings down in four of the last five years, and the negative trend forecast to continue this year and next. Tesco, by comparison, has delivered earnings per share growth of 65%, 82% and 12% over the last three consecutive years, and that looks set to continue, with analysts predicting 13%, 10% and 8% over the next three.
Same again, please
The Tesco share price has been given a further lift by its plans to offload operations in Malaysia and Thailand. Barring accidents, Lewis will move to fresh pastures next year bathed in glory following a successful turnaround operation.
Now some investors like to sell their winners, and that’s tempting here because, surely, Sainsbury’s is ready for a comeback? However, I still favour Tesco because it appears to boast the better bottom line. I’d buy it ahead of Sainsbury’s once again.
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Harvey Jones 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.