Supermarket sweep: Which FTSE 100 grocer is the best buy?
British supermarkets haven’t had an easy ride lately.
There’s been plenty for them to worry about – the biggest being the rising cost of imports as sterling has continued to slide (the pound dropped to €1.11 and $1.28 last week).
A weak pound has tightened profit margins. And with heavy competition from discount retailers, passing extra costs on to consumers means the big grocers risk losing shoppers to the likes of Aldi and Lidl. It’s a delicate balancing act.
Read more: Sterling continues downward slide amid Brexit jitters
But the problems don’t end there. Fidelity’s Leigh Himsworth points to the competitive threats from Waitrose’s quality offer, the home delivery of Ocado, as well as the potential threat of the beast that is Amazon.
This has prompted a flurry of action from some supermarkets. In light of all of this, let’s look at the three FTSE 100 supermarkets, and whether it’s time to buy or sell.
Tesco
With a 28 per cent market share, Tesco is the biggest of all the supermarkets in the UK – and it looks set to expand further with the launch of its own discount chain.
Indeed, this could set the retailer in good stead to compete with the German budget supermarkets.
Read more: Tesco reveals plans for a discount chain, but can it compete?
It was just 2015 when Tesco suffered some pretty huge losses, but the company has worked hard to turn the business around – and confidence among investors has clearly returned.
Over the past 12 months, Tesco’s share price has climbed an impressive 51 per cent, as it improved the shopping experience for its customers and adapted to challenges.
IG’s Chris Beauchamp says Tesco’s £3.7bn acquisition of wholsesale operator Booker earlier this year makes the supermarket the most interesting of the big three at present. “Booker’s integration should lead to further reductions in costs, giving the firm more ammunition to go head-to-head in price terms,” he says.
The IG analyst points out that Tesco has had 10 consecutive quarters of like-for-like sales growth, adding: “This shows that the firm has rediscovered some of the old magic touch. And while the two per cent yield is not exactly huge, it is well covered.”
Sainsbury’s
In April, the supermarket revealed plans to merge with Walmart-owned Asda.
At a first glance, there are plenty of reasons for investors to see this merger as a compelling opportunity. Himsworth points to the opportunities for staff, 10 per cent price cuts, an improved covenant for pensioners, technological tie-up with Walmart – the list goes on.
Read more: Sainsbury’s first quarter shows sluggish growth heading into Asda tie-up
Indeed, the rest of the market seems to agree that there is plenty to be positive about, with the share price of Sainsbury’s jumping 18 per cent in a matter of days.
And yet, interestingly, news of the the Asda deal actually prompted Himsworth – who manages Fidelity’s UK Opportunities fund – to sell his entire position in Sainsbury’s.
“It is the sheer fact that we are looking at the second largest company in the market buying the third largest that is causing a potential competition issue,” he explains.
“I like the idea of three strong brands (including Argos) getting together, as there will be massive buying benefits and rationalisation that may well work.
“But the deal will take at least until the end of 2019 to clear. Also, the complexity of the deal could mean a lack of focus on the day job for senior management, and could benefit the competitors in the short term, as could any store disposals.”
For these reasons, the Fidelity fund manager thinks it’s best to watch Sainsbury’s from the sidelines, and wait for a good point to buy again.
Morrisons
But while the largest three supermarkets embark on some massive changes, for Morrisons, it’s really just business as usual – apart from increased competition, that is.
“The push into wholesale will continue to constrain margin growth at Morrisons. And compared to the stories on offer at Sainsbury’s and Tesco, the firm doesn’t really have a compelling story with which to tempt investors,” says Beauchamp.
It’s worth pointing out that Morrisons shares have had a strong run – rallying by 25 per cent between March and May this year.
However, with that said, Beauchamp reckons most of the good news when it comes to Morrisons may well be in the share price. “The company has a low operating margin (2.7 per cent versus 11 per cent average for rivals), which would suggest that the firm has less to offer if price wars heat up once again.”
Also bear in mind that the surge in the share price means Morrisons no longer looks like a bargain buy.
The bottom line
While Morrisons looks solid, the picture could easily change for the supermarket as the market embarks on some huge shifts.
And while the potential for Sainsbury’s looks good, only time will tell whether it can turn its mergers into money-spinners.
So really, it’s Tesco that looks like the tastiest of the three FTSE 100 players.