These Household Names Look Ridiculously Cheap

“I believe smart investors should look closer at cheap names on the high street with big recovery potential.”

In the past, I have revealed how smart investors like you could be unearthing stock-market bargains by trawling the hated high street

I even shared how one of my most ‘hated’ investments ever – high-street baker Greggs – had already gained 17% in January alone!

Even Mike Ashley has taken a break from running Newcastle United to get in on the action – now he holds options to buy a chunk of Debenhams at a discount price!

WH Smith up 55%, Dixons up 58%, Thorntons up 247%

It shouldn’t be a secret anymore that unloved retail shares have been a rich source of stock-market bargains in recent years.

In fact, take a look at how these household retail names – which were once deeply unpopular with the City – have performed over the last twelve months:

  • WH Smith – up 55%…
  • Dixons – up 58%…
  • Thorntons – up 247%…!
  • Ocado – up 387%!!

Now I know what you’re thinking…

“Mark, don’t tell us what’s already gone up – talk about shares we can still jump on board!”

Actually, I think the biggest opportunity in the sector has yet to be uncovered by the market.

And it’s staring all of us right in the face – indeed, this sector accounts for 54p out of every £1 us Brits spend every day!

Previously, I’ve let slip that I was taking a very specific interest in two massive UK retailers:

“…perhaps my favourite ideas in the sector are William Morrison Supermarkets (LSE: MRW) and Tesco (LSE: TSCO). I think they’re superb defensive businesses, yielding 5% on average between them – and the market hates them both in 2014!!”

And now I’m going to tell you why I think the whole supermarket sector could well be a ‘no-brainer’ in 2014.

Supermarket sweep

You can already guess the response I get when I say I’m big fans of both of these dreaded, unpopular supermarket shares…

Person A: Why bother with Morrisons? Follow Buffett! Tesco is the only supermarket worth talking about..!

Person B: What?! No way – Tesco is finished, Morrisons is the cheaper option!

Person C: You’re both crazy, Morrisons and Tesco have been awful investments, Sainsbury’s (LSE: SBRY) is the only good UK supermarket!

If you’ve ever browsed online investing forums and websites, you’ve probably seen this argument play out thousands of times already…

Maybe it’s due to shopper loyalty, or perhaps a bad customer experience, or even just rubbish parking availability at their local store!

I worry that people get carried away when arguing about supermarket shares, and forget what I believe are some crucial fundamentals:

  • Tesco, Sainsbury’s and Morrisons are all solid businesses in their own right – combined they earned £4.7 billion operating profits last year, almost 74% of the whole industry!
  • They’re everywhere – these three retailers represent one third of all retail spending in the entire country!
  • All three shares seem to be hated by mainstream investors currently… and in my opinion, the whole sector looks cheap.
  • They’re all long-standing dividend stalwarts – yet a basket of the three shares is expected to yield more than 5.1% over the next 12 months!

And I can hardly believe this fundamental…

  • Their combined market cap is £38bn… but their property portfolios alone could be worth £50bn!

So, let me go one further than last time and say…

Forget your favourite shopping allegiances, Fools…

…I seriously think you could do well by sticking all three of these UK supermarkets in your trolley at current prices!

Buy £1 of property for 76 pence?

Let me just focus on that last point about the property portfolios…

I mean, it’s all well and good for me to talk about how dominant, high-yielding and profitable a basket of these three combined retail superpowers could be…

But it’s another thing entirely to say you could buy £1 of high-grade real estate for 76 pence!

Not a bad underpinning for your investment, right?!

These three supermarket giants own vast amounts of freehold property across Britain and beyond – and renting back to the reliable supermarkets would be highly desirable for yield-hungry landlords.

You see, while the UK property market has been recovering rapidly during the last couple of years, the market value of the supermarket sector has languished.

Just take a look at how the aggregate market value of Tesco, Sainsbury’s and Morrisons now compares to the estimated value of their freehold property portfolios:

mrmrwI find it amazing that these three profitable, well-embedded businesses are trading at such a discount to not only their earnings and dividends – but their assets, too.

You may wonder if it really counts for anything, since it’s obvious Tesco and co. aren’t going to liquidate £50bn of their stores overnight.

That may be so, but it doesn’t mean some of that property can’t be used to unlock value for shareholders, and it does underline just how out of favour these shares have become!

In fact, I’m not alone in recognising this – American activist fund Elliot Advisors has actually taken a stake in all three UK-listed supermarkets for this very reason.

In fact, Elliot Advisors reckons Tesco, Sainsbury’s and Morrisons could transfer their freeholds into a separate listed entity – which in theory should prompt the stock market to realise the full value of the properties…

And if sale and leaseback deals free up more money to buy back shares… expand into more convenience locations… or renovate old stores… it might make good business sense for these companies, too.

Anyway, that’s why I’m looking very closely at the UK supermarket sector in 2014 – and why I think you should do the same!

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> Mark owns shares in Greggs. The Motley Fool has recommended shares in William Morrison Supermarkets, Tesco and Debenhams. The Motley Fool owns shares in Tesco and Debenhams