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Do FTSE 100 supermarkets Sainsbury’s and Tesco make good long-term investments?

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With volatility in the financial markets and a potential lockdown hovering over our heads, supermarkets are again in the spotlight. FTSE 100 constituents Sainsbury (LSE:SBRY) and Tesco (LSE:TSCO) have both experienced share price volatility and each has mounting challenges to face. But do supermarkets make a good long-term investment and are they strong enough to survive and thrive in the coming years?

Challenging times

As the first lockdown got under way, it looked as if supermarket profits were rising, but it soon became apparent that additional costs would wipe out most of the gains. Costs include heightened sanitising efforts, a rise in recruitment and investing in technology to improve delivery efficiency. Government tax relief will partly offset these added costs, but shrinking profit margins are not so easily fixed.

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Amazon is elbowing its way into the sector with Amazon Fresh, delivering fresh food for free to its Prime customers in London and surrounding areas. Although a fledgling operation, this could rapidly become a bigger problem for existing supermarkets if Amazon continues its expansion throughout the UK. Tesco is planning to retaliate with a wider free delivery option and Morrisons is expanding its Amazon store. A price war could be ahead and wouldn’t be great for profits.

Share price volatility

Like most businesses in the FTSE 100, Sainsbury’s is experiencing share price volatility. Unfortunately, its troubles began before the pandemic hit and those problems haven’t gone away. It’s not as profitable as its competitors and is considered more expensive. It has a lot of debt and the rising popularity of budget supermarkets Aldi and Lidl have also added to its woes. Year-to-date, the Sainsbury’s share price is down nearly 14% and it suspended its dividend. It has a price-to-earnings ratio (P/E) of 33, based on earnings per share of 6p.

Nonetheless, a show of faith helped the Sainsbury’s share price rise last week after it was reported Czech billionaire Daniel Kretinsky has built a 3% stake in the supermarket via his investment vehicle VESA Equity Investment. The move makes him the fourth-largest shareholder in the group with a stake worth £130m. He may be an opportunist, but it gives shareholders confidence that they’re not investing in a lost cause. There’s speculation he wants to shake up the supermarket to boost profits. He also owns a 13% stake in Royal Mail.

Tesco shows ambition

The Tesco share price has also endured volatility, crashing to a low of £2.11 both in March and July. It’s creating 16,000 new jobs to ramp up its shift to online orders, showing it has confidence in its ability to meet consumer needs. Tesco owns Booker, which supplies independent grocery shops throughout the UK. This gives it an added income stream. It also benefits from its astronomical cache of data, which it gleans from customer transactions. The precision of data it collects helps Tesco plan product launches and tailor its marketing. Tesco’s P/E is 22, earnings per share are 10p and its dividend yield is 4%.

If you’re buying shares in the UK, supermarkets could be tempting as long-term investments. I think Sainsbury’s and Tesco are here to stay, but increasing competition and a changing consumer environment could pose challenges. I don’t think either offers much room for profit growth in the near term, but Tesco looks like it’s on a more profitable path long term.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Kirsteen has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Amazon. The Motley Fool UK has recommended Tesco and recommends the following options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls on Amazon. 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.

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