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Should You Buy Wm. Morrison Supermarkets plc, J Sainsbury plc Or Tesco PLC?

Investors are unhappy with Morrisons (LSE: MRW). They’re not happy that the grocer’s profit is in decay, and that only now a remedy is on the table. Perhaps it has arrived too late to take effect — at least it has if you’re a bear.

morrisonsA bull, meanwhile, would point out that the market only looks forward. To date in 2014 the shares are down nearly 25%, but while you wait for the share price to recover you can secure a prospective yield of 6.9%.

The bear, of course, shouts back that the dividend cover is thin and a cut looks likely. You — that is, a potential investor in Morrisons, or a shareholder wondering whether to cash out — are caught in the middle of the argument.

Which side is right? Could other supermarkets be a better bet, or should you dodge the sector altogether?

Fending competition

First off we’ll look at where Morrisons lagged its rivals. A supermarket’s business used to be relatively simple. Stores have fixed costs — rent and wages — so additional sales can see a dramatic increase in profits. The reverse is also true, whereby if sales fall then profits will tumble even faster.

In the last three years Morrisons has lost sales and fallen fast and hard. Two years ago underlying profits were £901m, while somewhere between £325m and £375m is forecast this year, a pittance by comparison.

Shoppers have defected to the hard discounters Aldi and Lidl and now, to tempt them back, Morrisons has unveiled price cuts to 1,000s of products. Morrisons claims the prices of everyday essentials will be 17% cheaper and, in the accompanying marketing, claims that the reductions aren’t “promotional prices” but new “everyday prices”.

The worst UK grocer?

tescoMorrisons rivals — Tesco (LSE: TSCO) and Sainsbury’s (LSE: SBRY) — will also need to follow suit and cut into their profit margins. Tesco has launched its own swathe of price cuts after two consecutive years of falling profits, with the chief executive, Philip Clarke, under increasing pressure. He hopes that store revamps will halt the decline in sales and indications are this is working. By the end of the year 650 stores will have been revamped and, after well received 2014 results, Clarke has bought himself time to see his turnaround plan through.

Sainsbury’s will have to join its rivals and cut prices to keep up, but investor sentiment has turned against them ahead of their full-year results next week. On Morrisons permanently reducing prices, Sainsbury’s shares fell more than 3%.

Of the UK’s biggest supermarkets, Sainsbury’s could be the one to avoid. Goldman Sachs recently warned that Sainsbury’s is only worth half its current stock market price, and despite strong operating performance, Sainsbury’s “has the weakest balance sheet of the UK grocers and a poor record of cash generation”.

The best UK grocer?

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Mark does not own shares in any company mentioned. The Motley Fool owns shares in Tesco and has recommended shares in Morrisons.