Investors’ Chronicle: Tesco, J Sainsbury, Marks and Spencer

BUY: Tesco (TSCO)

Shoppers may be trading down, but that still presents opportunities for the company, writes Christopher Akers.

The supermarket chain revealed a resilient performance in a challenging consumer demand and cost environment.

The company reaffirmed its full-year guidance, for a retail operating profit of £2.4bn-£2.6bn and free cash flow of over £1.8bn, as it enjoyed market share gains even as rivals struggled in the face of the German discount grocers.

Total like-for-like retail sales were up by 7.9 per cent for the six weeks to January 7. The strongest growth was posted by Booker, the wholesale side of the business, with Tesco offering price freezes on important catering lines. central Europe sales rose by 8.7 per cent, with the UK and Republic of Ireland bringing up the rear with growth of 7.8 per cent.

Sales rose by 6.4 per cent to £21.4bn for the entire 19-week period covered by the update, which includes the company’s third quarter. With sales growth sitting below the rate of inflation, the company has focused on a value-driven pricing approach. 

Shoppers’ understandable focus on prices was evident in Tesco’s statement that its Clubcard discount loyalty card is aiding competitiveness and “helped customers spend less on festive lines”.

Chief executive Ken Murphy said on an analyst call that “we have seen customers continuing to trade down, but that has taken a number of different forms, and we are seeing growth at both ends of our offer”. He pointed to price matching against Aldi and customers moving from national brands to value Tesco products, but also noted there had been growth in Tesco’s more expensive Finest range.

The shares trade at a consensus 12 times forward earnings, according to FactSet. This is below the five-year average of 13 times. We think this is an attractive rating given the company’s market position and competitive pricing, despite discounter challenges. Tesco, which takes around 28 per cent of UK supermarket sales, is the only full-line grocer to have grown share against pre-pandemic levels, and it enjoyed net switching gains in December. And City analysts think there are gains to be made on the shares — FactSet’s consensus target price is 275p, a 12 per cent uplift on the current price.

HOLD: J Sainsbury (SBRY)

A strong Christmas season underpinned a bullish trading update for the supermarket group, writes Christopher Akers.

Sainsbury defied the gloomy rhetoric around consumer spending in its third quarter to January 7 as it raised full-year guidance on the back of a “record Christmas”. The supermarket bumped up its retail free cash flow forecast from £500mn to £600mn for the year to March and said that underlying profit before tax should come in at the upper end of its previously guided range of £630mn to £690mn. But this couldn’t prevent a 2 per cent markdown of the shares, as the market remains wary of the impact of inflation on demand and the growing threat from the grocer’s discounting competitors.

Total retail sales (excluding fuel) rose by 7.1 per cent over the Christmas period against the previous year as shoppers splashed the cash on festivities and delivered record champagne and prosecco sales. Revenue was up by 5.2 per cent overall in the quarter. This was driven by price increases in an inflationary food environment — UK food inflation hit 13.3 per cent in December, according to the British Retail Consortium — albeit that Sainsbury’s has raised prices at a lower rate than the wider market.

General merchandise sales were up by 5 per cent in the period, as Argos gained market share and technology and household product sales performed strongly. But they were down by 7 per cent on a three-year basis, which presents the business with a headache. 

The profit guidance uplift came despite the confirmation earlier this month that the company would spend £185mn more on pay and benefits. This includes an increase in February in the salary base rate for retail staff, which will rise to £11 an hour nationally and £11.95 in London.

Charlie Huggins, Wealth Club’s head of equities, said that despite the strong Christmas performance, Sainsbury’s “simply can’t compete with the prices of Aldi and Lidl”.

This price threat is real. The German discounters each boosted sales by around a quarter over Christmas and have significantly increased their UK market share over the past five years. While Sainsbury’s competitive pricing approach has had some success, the growing popularity of Aldi and Lidl remains a key risk as consumers continue to trade down and look for cheaper alternatives as bills rise and wage growth fails to keep up.

Sainsbury’s valuation remains attractive, despite it having become more expensive since last autumn. The shares trade at 12 times forward earnings, according to FactSet, which sits at the five-year average. While this is higher than the 10 times forward valuation in November, this rating is still undemanding given the company’s performance and outlook.

HOLD: Marks and Spencer (MKS)

Marks and Spencer increased its market share over Christmas, with both food and clothing sales growing strongly. However, the retailer made no reference to profit margins and was vague on cost pressures, writes Jemma Slingo. 

In the 13 weeks to December 31, like-for-like food sales rose by 6.3 per cent, and clothing and homeware sales grew by 8.6 per cent. As a result, the food division enjoyed its highest ever recorded market share, and clothing and home achieved its highest market share in seven years, rising above 10 per cent for the first time since 2015. 

Encouragingly, management reported strong demand for both its value food products and its top-tier M&S Collection items. Analysts at Peel Hunt suggested that M&S was poaching customers from Waitrose, “but in general the proposition is currying favour with all types of shopper”. Meanwhile, revenue from menswear and formalwear shot up by 40 per cent, and partywear sales more than doubled. 

As at Next, in-person shopping fuelled M&S’s growth over the festive period. In-store sales increased 12.8 per cent, with standout early performances from new stores in Colchester and Chesterfield. In contrast, online sales only rose by 0.7 per cent. 

The trading update is light on detail, however. While the group is confident of meeting full-year profit guidance, it provided no margin figures. It was also vague about its inventory, simply saying that “stock into sale was in line with plan and clearance rates to date have been strong”.

In light of the update, analysts at Peel Hunt raised their profit before tax forecasts from £375mn to £410mn for this year, and from £310mn to £410mn for next year. The retailer will publish its results for the year ended April 2 2022 on May 24 2022.