Tesco (LSE: TSCO) is a company that has divided the investment community for some years now, and today the argument is about whether the company is past the worst and is on the road to recovery.
After a false start in the first half of the year, the shares dropped back, but we’ve seen a 44% gain since mid-June to today’s 209p. Looking at the record of the past five years of earnings slump followed by forecasts of a return to strong EPS growth this year, I can see why people might think it’s time to pile back in. But I really don’t see it as time to buy.
Forecasts for this year still put the shares on a very high P/E of 28, dropping only as far as 21 on February 2018 forecasts, and that’s with dividends expected to only just return to a 1.2% yield by 2018.
Tesco shares look to me to be valued as if the competition from cut-price competitors like Lidl and Aldi has been beaten and that Tesco is once again in the ascendancy. But I see the drive for “cheaper is better” as being still in its infancy.
The Institute for Fiscal Studies has just predicted a 10-year pay squeeze, with real incomes set to be lower in 2021 than they were in 2008. Do you think that’s going to get more and more people queuing up to buy Tesco’s Finest range? I don’t. In fact, I see a decade of shoppers increasingly visiting the cheapies and ignoring our overpriced traditional supermarkets.
And if Aldi and Lidl don’t cut it, Asda is increasingly seen as the nation’s best value full-service groceries supplier. I would not buy Tesco shares now.
Upmarket squeeze
Despite the cheaper valuation of the shares, I don’t see any greater attraction in J Sainsbury (LSE: SBRY). We’re looking at a forward P/E of around 12 with a mooted dividend yield of 4.4%, but that’s predicated on two more years of declining earnings. That suggests Sainsbury could be at least a couple of years behind Tesco in any recovery in earnings, even if you think Tesco forecasts are realistic (and I’m not convinced).
Sainsbury is even more of a haven for those looking for up-market produce at up-market prices, and the next ten years of earnings squeeze could well hit the company even harder than Tesco. Do you think that real incomes in 2021 coming in lower than they were back in 2008 is a recipe for success for upmarket food sellers? I don’t.
Sainsbury’s interim results on 9 November opened with all sorts up upbeat exhortations, including writing things in orange as if that made any difference.
But once past the usual puffery, we saw a report of a 10% fall in underlying pre-tax profit, a 6.7% drop in underlying earnings per share, and a drop in return on capital employed from 8.5% a year previously to 8%.
In its outlook statement, Sainsbury told us that “pricing pressures continue to impact margins“. You bet they do! And if you think there’s any likelihood that price competition is going to ease up any time during the lost economic decade we’re likely to be facing as we rush headlong off the Brexit cliff, well, it’s your money and your call.