Investment ideas don’t get much more boring than the UK’s largest supermarket, Tesco (LSE: TSCO).
Boring can be good in the stock market, but we all need a bit of excitement. So today I’m going to look at Tesco and at a much smaller retailer that I think could be a long-term winner.
Big and well run
The efforts being made by Sainsbury’s and Asda to merge their operations tell you something about the advantage of being big in groceries.
However, Tesco is already roughly the same size as its two rivals combined. This means that chief executive Dave Lewis doesn’t need to worry about trying to push through complex merger deals, despite regulatory opposition.
Mr Lewis has been able to focus on two areas — operational excellence and finding other routes to growth. In my view he’s accomplished both of these feats. He’s made improvements to the group’s business practices to treat suppliers more fairly, and improved the performance of its supermarkets.
Alongside this, Mr Lewis has acquired fast-growing food wholesaler Booker, which has given the group a sizeable share of the convenience store and restaurant foodservice markets.
Financial turnaround
Tesco’s financial results reflect Mr Lewis’s changes. After falling to a low of £54m in 2016, group sales are expected to have reached nearly £61bn in the year ended 24 February. Profits have bounced back too. Analysts expect the firm’s adjusted earnings per share to have risen by 17% to 14p per share last year.
At the time of writing, Tesco shares trade on 14 times 2019/20 forecast earnings, with an expected yield of 3.1%.
I wouldn’t describe this as the bargain of the year. But I do think the shares remain a decent buy for investors wanting a reliable long-term income.
Wine goes online
Shares in wine merchant Majestic Wine (LSE: WINE) were down by 12% at the time of writing. The shares have now fallen by about 40% in six months as tough trading on the high street has dented the group’s profits.
Today’s fall was triggered by news that the dividend may be cut to fund extra investment in the group’s online business, Naked Wines. This former start-up buys wine directly from winemakers to sell to customers.
Chief executive Rowan Gormley — who founded Naked — has decided to scale back the group’s high street retail business and focus on online growth. The numbers suggest to me that Mr Gormley is probably right to make this decision.
During the six months to 1 October, Naked sales rose by 14% to £75.7m, while retail sales only rose by 1.9% to £122.9m. At this rate, it won’t be long until Naked is the group’s biggest business.
Naked Wines is already Majestic’s most profitable business, with half-year adjusted operating margin of 4.2%, compared to 2.7% for the retail business.
Buy, sell or hold?
The group will be rebranded as Naked Wines and profitable stores will be migrated to trade under the Naked brand.
Are the shares a buy? Perhaps. Given consumers’ growing preference for authentic products with a good story behind them, I think Naked Wines could be a long-term winner. Although earnings visibility is limited, I think the shares could be a long-term buy at under 250p.