Why Invest in Supermarket Stocks?

Supermarket stocks have taken a bashing over the past year thanks to the expenses scandal at Tesco and the rise of budget food retail usurpers. Is there any value to be had?

Ken Perkins 8 April, 2015 | 10:04AM

Tesco

We think Tesco's scale allows the firm to operate more efficiently than many competitors, and its convenient locations and loyalty program should continue to drive traffic. However, we don't have enough confidence in Tesco's ability to sustain excess returns over the long term to assign the firm an economic moat. Switching costs are non-existent in grocery retail, and competing on price while sustaining excess returns is a tough proposition. Moaty defensive retailers tend to have clear cost advantages, and because Tesco's competitors have sufficient scale to remain competitive on price while touting points of differentiation many of which could be replicated over a decade, we don't think Tesco has a material leg up on its peers.

Tesco is the largest food retailer in the U.K., where it also sells petrol and higher-margin general merchandise in multiple channels, including large-store formats, online, and convenience stores.

Tesco also operates more than 3,500 stores in Europe and Asia which make up 30% of sales and profits. We think the firm remains well positioned in Korea, Malaysia, and Thailand, but results in other regions have been more challenging. The company recently decided to exit the U.S., where its Fresh & Easy concept failed to gain enough traction to support adequate returns on invested capital. It also exited Japan in 2011, as deflationary pressures, cost-conscious consumers, and fierce competition weighed on profitability. China and India remain areas of opportunity, but achieving results comparable to those in the U.K. will be no small feat given regional market dynamics.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Sainsbury (J) PLC190.15 GBX0.08
Tesco PLC224.70 GBX-0.31

About Author

Ken Perkins  is a Morningstar equity analyst covering consumer packaged goods firms.

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