It was a big week for supermarkets last week as the two leading players – Tesco and Sainsbury’s – announced their results, with both impressing markets.
Starting with the largest grocer, Tesco had a bumper third quarter and Christmas period, with its dominant market share helping to keep customers coming through the door.
Sophie Lund-Yates, lead equity analyst at Hargreaves Lansdown, said the results were particularly impressive given the growing pressure on household incomes and the unstoppable rise of the discount supermarkets.
“The other string to Tesco’s bow is wholesaler Booker, which offers a diverse source of income. Especially as catering trends normalise, the group’s benefitting from the wheels of hospitality turning once more,” she said.
However, she noted that “there is an elephant in the room” in the form of discounting, with offers such as the Aldi Price Match being very successful, but potentially eating into margins.
“The tug of war between pricing and volumes is clearly producing a good result, which is why profit expectations have been reiterated, but it’s still hardly an ideal state of affairs for the big names in industry,” Lund-Yates said.
Total return of Tesco and Sainsbury’s in 2022
Source: FE Analytics
Turning to Sainsbury’s, the rival grocer also had a strong set of results with Christmas and third-quarter sales ahead of market expectations
Chris Beckett, head of equity research at Quilter Cheviot, noted the company had “executed its Christmas period very well and has had the additional benefit of the World Cup adding to sales”.
There was a small decline in sales volume in groceries overall, he added, which suggests that unlike Tesco, the overall revenue was driven by higher prices.
“Within this we are seeing evidence of consumer bifurcation, with the cost-of-living squeeze not being felt equally. Sainsbury’s had good sales on its premium ranges, along with strong own brand sales on entry point products,” said Beckett.
He added that the firm had benefited from inflation with profit anticipated to be at top end of the previously expected range as it managed to pass price rises on to the end consumer.
Both firms struggled last year, however, as the above chart shows, with Sainsbury’s shares making investors a 15.8% total loss, while Tesco made an 18.8% loss.
Leigh Himsworth, portfolio manager of the Fidelity UK Opportunities fund, said given the choice he would invest in Tesco, although said there would have been an even better option 18 months ago in the form of Morrisons, which delisted in October 2021 when it was taken private.
“In an environment where consumers are looking to save where they can, Morrisons would have been an obvious call with its bullet-proof balance sheet and keen eye for a tempting offer,” he said.
“The acquisition by private equity has robbed market investors of this opportunity, however, and has left the group highly indebted and with a lacklustre off that is seeing its market share drop. Something similar appears to be weakening the Waitrose offer too.”
This shift in dynamic however has opened up new opportunities for Tesco, which has invested in growing its customer base and refocused the business in recent years, strengthening the balance sheet and now owning more than 25% of the market share.
“Tesco should be in a great position to benefit from the cost conscious, yet their ‘Finest’ range should appeal to those seeking to eat-out less, though still wanting to treat themselves,” said Himsworth.
Yet the share price rating is “hardly demanding”, with shares on an enterprise value to operating profit (EV/EBIT) multiple of 11.5x, with modest sales growth and a yield of 4.3%.
James Henderson of the portfolio manager of Henderson Opportunities Trust and Lowland Investment Company said he too would – and indeed does – back Tesco.
Although margins have been reduced, it is “holding on to market share and competing successfully” and “showing its strengths in this difficult period”.
“It is the leader and it is not giving ground, while in recent years Sainsbury has losing market share.”
He added that the current dividend is attractive but should also grow, which should give investors confidence that it is not a “value trap”.
Ocado
Finally, a note on Ocado, which is to release results this week. The firm has had a torrid time since the pandemic, when investors clamoured for shares in the online-only grocer.
Now that people have returned to buying their groceries in person, however, the shares have tanked, down 63% in 2022.
AJ Bell investment director Russ Mould said that the firm is one of the long list of Covid winners that have fallen out of favour as growth rates have proved hard to sustain.
Rising interest rates have taken a toll on perceived growth stocks, especially those that offer the hope of profits tomorrow but losses today. Ocado isn’t forecast by analysts to make a profit until 2025 at the earliest.
Total return of Ocado in 2022
Source: FE Analytics
“A profit warning alongside September’s third-quarter update did not help sentiment either, as Ocado flagged how customers were trading down through brands and cutting basket size thanks to the cost-of-living crisis (something with which the presence of Marks & Spencer-branded product on the delivery platform, thanks to the 50-50 venture, may not have helped),” Mould said.
“The shares have since rallied, helped by the latest licensing deal for the Ocado Smart Platform, this time with South Korea’s Lotte Shopping, and shareholders will look for an update here and progress at the other licensing deals, in the US, France, Sweden, Canada and others. But the initial focus will fall on some hard, near-term numbers.”