Is the challenge too great?
At 197p, Tescos forward price-to-earnings (PER) ratio runs at about 19. Thats high. Those hoping for a turnaround in fortunes are already seeing a lot of that priced in.
City analysts following the firm expect earnings to bounce back by around 38% for the year to February 2017. However, looking at the recent interim report, the scale and scope of the firms problems is evident in the sub-headings chosen to list remedial actions the company is taking. Those sub-headings read:
- Regaining competitiveness in core UK business,
- Protecting and strengthening the balance sheet,
- Rebuilding trust and transparency.
A firm that has lost its competitive position in its core business, has a weak balance sheet and which has lost transparency (and the trust of its customers and investors) has a long way to travel to return to former glories.
Naturally, Tesco is making some progress. Yet, I think the task remains too large. On top of the firms internal problems, changes in the supermarket sector strike me as structural this time, and the challenges facing Tesco seem likely to intensify, not subside.
In all firms, it can help to gauge the directors view of a businesss progress and future prospects by looking at decisions regarding dividends. I see that Tesco is not offering an interim dividend this time. Tesco is not for me.
No growth on the cards
Since last months second-quarter update, where Sainsburyssaid it expects full-year underlying profit before tax to be moderately ahead of expectations, the shares have elevated by 21%. At todays 274p share price, the forward PER sits at about 13 for year to March 2017, and the forward dividend yield runs at around 3.8%, with forward earnings covering the payout twice.
City analysts following the firm dont expect any growth, though. They think earnings will decline 20% during the current year and 1% next year. Sainsburys faces the same structural challenges that Tesco faces, with nimble, discounting competition such as Aldi, Lidl and others attacking industry margins and biting chunks from the big supermarket operators market shares.
Sainsburys is busy applying similar root-and-branch measures to ensure its survival. Like Tesco, Sainsburys is treading water rather than realigning itself for growth, I feel. As such, the firms valuation looks pricey to me. Id much rather see single-digit PERs and dividend yields well above 5% from the big supermarket operators such as Sainsburys and Tesco. So, this oneis not for me either.
Growing market share
Tesco and Sainsburys are both active in the local convenience store market, but McColls Retail Group specialises in that sector. As such, the firm is without the encumbrance of a big supermarket estate and all the difficulties that come with it.
McColls has over 1,300 stores throughout England,Scotland and Wales and is expanding fast. Unlike Tesco and Sainsburys, McColls directors focus is on growth initiatives rather than survivalmeasures.
Todays 149p share price throws up a forward PER of just under 10 for 2016 and the dividend yield runs at around 6.8% with earnings expected to cover the payout 1.5 times. The firm seems well worth further research and attracts me more than the big supermarket goliaths.
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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.