Tesco Upgraded by Equity Analysts

In a supermarket sector overview, Morningstar equity analysts have upgraded their value for Tesco, but downgraded Sainsbury's

Ioannis Pontikis 21 March, 2018 | 8:42AM
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supermarket food inflation retail sales food retailer tesco uk stocks

After taking a fresh look at the three U.K. grocers under our coverage, we are raising our fair value estimate for Tesco (TSCO) to £2.30 per share from £1.44, while reducing Sainsbury’s (SBRY) to £2.31 from £3.17 and leaving our fair value estimate for Morrisons (MRW) unchanged at £2.02.

Although we are maintaining our no-moat ratings for the group, we change our previously stable trend rating for Sainsbury’s to negative and reiterate Tesco’s stable and Morrisons' negative trend ratings.

Our revised trend ratings and fair value estimates reflect our views for each grocer on three important aspects of today’s UK food retail industry: channel positioning, execution and recovery plan in place, and strategic growth options ahead. With significant changes in our assessments for Tesco and J Sainsbury, we now believe all companies are roughly fairly valued, with Tesco being the cheapest of the three on a relative basis.

Sainsbury’s Faces Challenges

We see J Sainsbury’s competitive positioning as challenged by its suboptimal strategic decision to expand its offering beyond food by acquiring Argos in a period when most competitors are focused on and investing in expanding volumes and driving traffic in the core food segment.

While Morrisons' strategy of diversifying its channel exposure through capital-light partnerships is logical given the circumstances, strong initial results are off of a low base and shouldn’t be enough to offset competitive pressures from discounters and its Big Four peers.

Tesco is outperforming its closer peers in key metrics such as grocery volumes, like-for-like sales growth, and large-store sales growth, while its recent Booker Group acquisition aligns with the firm’s strategic plan to further boost scale by consolidating its supplier base and indirectly enhance its food sales through Booker’s overlapping food category efforts.

We expect the UK food retail market to grow by 2.9% over the following five years, with discounters, online, and convenience significantly outpacing the more traditional but still important hypermarket/supermarket channel. The latter is dominated by the so-called Big Four grocers; we expect this segment to continue showing negative volume growth, with Asda and Sainsbury’s contributing the most to the underperformance.

Morrisons' large stores, which account for the vast majority of the group’s sales, should grow 0.5% a year by 2022, while Tesco’s large stores should continue to outperform all of its Big Four rivals, growing by about 1.5% for the same period. A normalised UK food retail environment should see permanently lower midcycle margins and returns on invested capital, relative to historical results before 2015, in the future.

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
Sainsbury (J) PLC275.40 GBX-1.43Rating
Tesco PLC309.00 GBX-0.68Rating

About Author

Ioannis Pontikis  is an Equity Analyst for Morningstar

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