Hobson: My Favourite Supermarket Stock

As rumours abound regarding a takeover bid for Morrisons, Rodney Hobson weighs up the risks involved when buying stocks that are potential M&A targets

Rodney Hobson 14 February, 2014 | 12:04AM
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A curious rumour swept the market this week suggesting that supermarket group Morrison (MRW) would be taken private by the Morrison family acting with the backing of private equity funds. It’s always possible, but I think that a price tag of about £7 billion makes the notion unlikely. So did the market, which soon marked the shares back down again.

I never buy shares in potential takeover targets and I don’t advice anyone else to do so, unless you are particularly adept at spotting companies that do get taken over. You are likely to buy a lot of duds for each right guess you make.

I do argue that supermarkets are the best place among high street retailers for investors to look, and there is something to be said for buying Morrison shares below 240p, with a yield of over 5% better than most retailers and a price/earnings ratio well below 10 making the shares comparatively cheap.

However, Morrison is getting squeezed by Sainsbury (SBRY) and Tesco (TSCO) among well established UK supermarkets and by Aldi and Lidl among budget chains. It has been slow to get online and to develop minimarkets, the two growth areas, and is having to spend money to catch up.

I maintain my stance that Sainsbury is the best share buy among supermarkets and I am retaining my holding.

What the Analysts Say

Sainsbury was the leading U.K. grocer until the mid-1990s, but Tesco and Asda garnered scale by building out store concepts and better articulating value propositions and now lead the market, says Morningstar equity analyst Ken Perkins.

We still think Sainsbury has enough scale to remain reasonably competitive on price, but we don't believe it possesses a cost advantage relative to other market leaders. Moreover, switching costs are virtually non-existent in the grocery industry, and it's not clear that Sainsbury's points of differentiation are strong enough to ensure that excess returns on capital can be sustained over the long term. Because of these factors, we do not assign Sainsbury an economic moat.

Despite numerous challenges, Sainsbury is well positioned to capture incremental share in the faster-growing convenience store channel, in our view. The company increased its convenience store base by more than 60% over the past five years – operating more than 500 stores at the end of fiscal 2013, and we still see a long runway for growth, since we estimate Sainsbury's store count represents only 1% of convenience stores. Returns on capital could also improve, given that convenience stores tend to be higher margin and consumers shopping in multiple channels tend to spend much more than those shopping in supermarkets alone.

Rodney Hobson is a long-term investor commenting on his own portfolio; his comments are for informational purposes only and should not be construed as investment advice.

Data provided by Morningstar Select

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Rodney Hobson

Rodney Hobson  is a columnist for Morningstar.co.uk and author of several investing books, including The Dividend Investor and How to Build a Share Portfolio.