2014 has been nothing short of a disaster for investors in J Sainsbury (LSE: SBRY), Wm. Morrison (LSE: MRW) and Tesco (LSE: TSCO). Thats because the share prices of the three stocks have fallen by 28%, 29% and 41% respectively during the course of the year.
Clearly, the reason for the share price falls has been poor operating performance, with a price war and shifting consumer tastes causing the bottom lines of all three companies to decline. Furthermore, forecasting errors at Tesco have also weighed heavily on its share price, which has dented investor confidence in the company to a relatively large degree.
Margin Of Safety
The market seems to be of the opinion that much worse is still to come for the three supermarkets. This is best evidenced through looking at their current valuations, with Sainsburys having a price to book (P/E) ratio of 0.8, and Morrisons and Tescos P/B ratios being 0.9 and 1.1 respectively. All three of these figures are exceptionally low and, as a result, include a wide margin of safety. In other words, if things do get worse then the share prices of the three companies may not be hit as hard as they have been and, should things fail to get worse, there could be scope for an upward rerating.
In terms of potential catalysts for improved future operational performance (or at least a stabilisation), there seem to be three main areas of hope for investors in the stocks. The first is a shift in consumer tastes away from the no-frills shopping experience of the likes of Aldi and Lidl and toward the better service and selection that major supermarkets offer. This could take place as a result of increases in real disposable income that are expected in 2015, with next year expected to be the first time that wage growth outstrips inflation since the start of the credit crunch.
The second potential catalyst is a slowdown in the rate of growth of discount stores such as Aldi and Lidl. Indeed, the two companies have grown extremely quickly and been hugely successful in recent years. However, they are unlikely to grow at such a vast pace in perpetuity and, inevitably, there will be a slowdown in their rate of growth. This could be because further locations are not as prime as existing sites, and also because of a saturation within the no-frills space.
This leads to the third potential catalyst, which is for Sainsburys, Morrisons and Tesco to compete directly with no-frills operators through new discount brands. At present, only Sainsburys is trying this option, in the form of a joint venture with Netto; however, Morrisons and Tesco may follow should it prove successful. Such a move could bring back previous customers and persuade existing customers to stick with the Sainsburys/Morrisons/Tesco brand, albeit in a slightly different form moving forward.
With Sainsburys, Morrisons and Tesco all due to post disappointing bottom line figures in the current year, with profit falls of 18%, 51% and 48% expected (respectively), the short term could see little, if any, improvement in their share prices. This will especially be the case if they endure a lacklustre Christmas trading period.
However, looking ahead to 2015, all three companies could see a stabilisation in their performance. Certainly, the turnaround of these three companies will take a lot longer than one year, but the green shoots of recovery could begin to sprout next year, as the UK consumer finally starts to feel the effects of an improved economy in his/her back pocket.
As for which of the three supermarkets could be the best buy Sainsburys has the lowest valuation and is the only one that is attempting to beat the no-frills operators at their own game. As a result, it appears to be the leader of the three when it comes to investment potential, although lumps and bumps must be expected by investors in all three stocks over the short to medium term.
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Peter Stephens owns shares of Morrisons, Sainsbury (J), and Tesco. The Motley Fool UK owns shares of Tesco. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.