Supermarket Stocks Rally as Tesco Plans to Axe Non-core UK Assets

Supermarket share price rises after Tesco is reported to make plans to restructure its non-core businesses

Karen Kwok 11 April, 2016 | 5:22PM
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Shares in Tesco (TSCO) posted a sharp gain on Monday after the retailer reported to make plans to dispose of its non-core lose-making businesses as it focuses on reviving its main grocery business.

Citing unnamed sources, Sky News said it has learnt that Tesco, the UK’s largest retailer, has appointed investment banking adviser Greenhill to work on the sale of Dobbies, the garden centre business which Tesco bought in 2008 for £156 million. Dobbies has 35 garden centres across the UK, but recorded a total loss of £48 million in the financial 2015 year.

It is reported that Tesco also planned to sell coffee shop chain Harris & Hoole as well as restaurant chain Giraffe and bakery business Euphorium. The news came after Tesco revealed plans to close its Nutricentre health and wellbeing business at the end of last month.

Major retailers in the UK have posted gains of share prices as the market digested the news of Tesco disposing its non-core businesses. Tesco gained 1.8% to 194p while Sainsbury (SBRY) shares were up 1.2% to 292p, at 4pm on Monday. Shares of another grocer Morrison (MRW) were also slightly up to 201.43p.

Tesco is scheduled to unveil its first quarter of underlying sales growth for more than three years when the retailer reports its full-year results on Wednesday April 13. Morningstar analyst Ken Perkins expected growth of the company to be returned to a low-single-digit ate over the long term. He also forecasted a 2% annual revenue growth for the company as a whole over the next five years.

“Given the competitive pressures Tesco currently faces in the UK and abroad, we believe that the company could improve its credit metrics by reducing debt,” Perkins commented. “We expect reinvesting cash flows back into the U.K. business and the international store base will be a primary use of cash.”

Perkins also expected Tesco to repurchase 1%-2% of its shares annually over the long term. Tesco is well positioned to capture its fair share of growth in the online channel, Perkins added, although AmazonFresh could pose a larger threat down the road. The stock is currently rated as a four-star undervalued stock by Morningstar analysts.

UK Supermarkets Threatened by Online Challengers

The U.K. grocery industry is very competitive, with e-commerce firms and discounters challenging traditional grocers, and rivalry has intensified over the past few years.

Most retailers spent the better part of the past decade increasing square footage to drive sales growth, but some of these investments failed to produce expected returns, particularly when the global economy slowed and consumers started spending more online. While Tesco is planning to axe its non-core businesses to fuel its revenue growth, other retailers like Sainsbury and Morrison also drew up plans to boost growth. 

Sainsbury's has offered to acquire Argos from Home Retail Group. The impact of acquiring Argos could help Sainsbury bolster its competitive position in an era of e-commerce, as Sainsbury will be uniquely positioned to sell general merchandise products in the online channel.

Sainsbury’s pays a dividend, and without a material margin cut related to price investments, Morningstar analysts expect the dividend to increase in line with earnings. The stock currently yields at 6.2%. In a normal competitive environment, analysts expect Sainsbury to repurchase 1%-2% of its shares annually. The stock is rated as a three-star fair-valued stock by Morningstar analysts.

Likewise, another retailer Morrison Supermarkets has entered a new supply agreement with US online retail giant Amazon.com Inc (AMZN) and has agreed new terms in principle with online grocery delivery company Ocado Group PLC (OCDO) Morningstar analysts said its partnership with Ocado was a solid strategic move, as it should allow the company to quickly expand into the online channel without the execution risk associated with building this platform from scratch.

Morrison also pays a dividend, which Morningstar analysts expect will increase in line with earnings, management is targeting a 50% pay-out ratio, so long as competitive conditions don't deteriorate further. Also analysts are expected to see the firm repurchase some of its shares annually as capital expenditures moderate. The stock is rated as a two-star overvalued stock by Morningstar analysts. 

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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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Amazon.com Inc186.65 USD0.80Rating
Ocado Group PLC404.20 GBX0.15Rating
Sainsbury (J) PLC275.60 GBX-4.31Rating
Tesco PLC356.40 GBX-0.83Rating

About Author

Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk

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