For many investors, the supermarket sector is a source of great frustration. What was once a relatively steady, stable and resilient industry has now become less profitable, less popular and anything but defensive. As such, the popularity of supermarkets such as Tesco (LSE: TSCO) and Sainsbury’s (LSE: SBRY) has deteriorated considerably among investors, with the two companies posting a decline in their share prices of 49% and 27% respectively during the last five years.
Clearly, there is no quick-fix solution to their problems. However, they both appear to be doing all of the right things to turn their fortunes around. In the case of Tesco, its new management team has ditched the company’s obsession with diversity and has begun the process of rationalising the business through the sale of non-core assets. As a result, Tesco is likely to emerge as a leaner and more efficient business, with its bottom line likely to improve significantly over the long term.
Meanwhile, Sainsbury’s has never been as bloated as Tesco. It has remained UK-focused and, clothing and some other home products aside, has continued to be a pure play supermarket in recent years. However, where it is likely to succeed is with regard to its pricing strategy, with it having moved away from focusing on price and towards an emphasis on quality at an affordable price. This should help Sainsbury’s to improve its margins and is likely to appeal to shoppers who have more money in their pockets (in real terms) with each month that passes by at the present time.
Of course, neither company is expected to deliver strong performance in the current year. In fact, Tesco’s bottom line is forecast to fall by 14% this financial year, while Sainsbury’s earnings are due to be 19% lower than they were in the previous year. Clearly, this is disappointing but, realistically, is not a major surprise given their performance in prior years.
However, what may be a surprise for some investors is how Tesco is set to perform next year. Its earnings are forecast to rise by as much as 37% as an improved strategy that focuses on higher volumes and lower margins begins to take effect. As such, Tesco trades on a price to earnings growth (PEG) ratio of just 0.5, which indicates that its share price could move significantly higher.
Sainsbury’s meanwhile, is due to post a flat level of profitability next year. Although it would be an improvement on the current year, it is unlikely to stimulate investor sentiment to the same extent as Tesco. And, while Sainsbury’s does have a refreshed strategy that appears to be sound, its management team may have less scope to change things as per their peers as Tesco. That’s because the company’s CEO served under the previous CEO and, as we saw at Tesco in recent years, it can be difficult to make the wholesale changes needed to turn a business around when you have an internally promoted CEO.
So, while both stocks appear to be worth buying right now, Tesco’s more appealing growth prospects and licence to cut, sell and change to whatever lengths are necessary make it the preferred choice at the present time.