Why you should buy shares in Sainsbury’s
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Associate Editor
David Stevenson Oct 02, 2009
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We've been Tesco (LSE: TSCO) fans for several months now. And it's worked out pretty well. But in stock market terms, Britain's biggest retailer just isn't quite as cheap as it used to be.
What's more, over that time it has comfortably out-shot the share price of one of its main rivals, J Sainsbury (LSE: SBRY), which has severely lagged behind the overall market.
But this may be about to change – which means that Sainsbury's could now be the supermarket stock to hold...
Tesco's done well
We've been keen on Tesco shares from when they hit a four-year low back in November 2008 (Is it time to buy Tesco shares?). Since then the shares have risen by 36% and have outrun the FTSE 100 index by around 3%. Every little helps.
But along with much of the rest of the London equity market, Tesco shares are now rather more highly rated than they were six months ago. Instead of selling on a forward price-to-earnings ratio (PER) of below ten times, they're now standing on 13 times consensus City estimates for the year to February 2010, and 12 times for the following 12 months. And rather than yielding a prospective 4.5%, the rising share price means the forward yield has been reduced to just 3.6%.
OK, compared with some of the racy multiples the stock market has put on Tesco shares in the past, particularly at the start of the decade when the valuation was almost double this level, that's not too pricey.
But as we've been pointing out in Money Morning (Investors are right to be worried – we're heading for a correction), the stock market is running a long way ahead of what's happening in the real world. There are huge question marks over whether an economic rebound is really happening, as yesterday's weak manufacturing sector data showed.
Activity in the sector continued to shrink in September, as employers cut jobs for the 17th month in a row, and the pick-up in new orders slowed. "The latest manufacturing data suggests the industrial recovery is losing steam", says Vicki Redwood of Capital Economics. As Edward Hadas points out on Breakingviews.com, "unless the recovery takes a sharp V-shape, earnings could disappoint, dragging shares down".
A surprising laggard of the stock market rally
Yet we still need to eat. Which makes it all the more surprising that one of the biggest laggards in the stock market rally has been another supermarket chain. J Sainsbury has underperformed Tesco by some 15% since the London stock market low on 9 March, and is now priced more cheaply than it was a year ago.
What's even more shocking (particularly if you've been a Sainsbury's shareholder all this time), is that the stock price is actually lower than it was fully 18 years ago. Clearly there have been several reasons for this – such as the group losing market share, some disappointing profit announcements, and a failed bid for the Safeway chain – while the collapse of a takeover offer by the Qatari-backed Delta Two investment fund in 2007 was very bad news for the existing owners.
But now this bad run could be about to reverse.
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To date, the net effect of its share price underperformance has been to 'de-rate' Sainsbury's shares sharply. In other words, the company's net profits have risen much more than the stock price. Over the last five years, for example, the underlying earnings per share (EPS) have trebled, while the share price is only up, would you believe, about 10%.
In contrast, over the same timeframe, Tesco's EPS have grown by just over 50%. Still good, but hardly comparable. So Sainsbury's prospective valuation, which has historically been much higher than Tesco's to reflect its faster growth, has now dropped to a level that's only slightly greater, at 12.5 times next year's net profits. What's more, Sainsbury's prospective yield is almost 5%.
In a nutshell, Sainsbury's is now cheap, full stop.
Sainsbury's is the supermarket stock to hold
And the improving relative valuation is only part of the story. Sainsbury's is fighting back. It has just announced a multi-million pound investment into a new coupon-based loyalty scheme to retain and reward customers. This is the company's biggest investment in customer loyalty since launching the Nectar card in 2002.
Further, it's growing faster than average, too. The latest TNS trade data show a 7% sales increase for the 12 weeks to 6 September compared with overall grocery sector growth of 5.2%. And next Wednesday's trading update for the 16 weeks to 3 October should confirm this trend is continuing. "In our view, sales growth for Sainsbury's will continue to be higher than the overall market", say Jaime Vasquez and Shashank Savia at JP Morgan. Their target is 370p.
As cyclical shares have roared ahead over the last six months, food retailers have generally underperformed. That's because they're in a 'defensive' sector, which doesn't depend on economic growth to make money. But grocers are likely to become flavour of the month again when the cyclicals have run out of puff.
So we wouldn't put you off continuing to hold your Tesco shares for now, because they still look reasonably cheap. But if you only want to hold one supermarket stock, you could switch out, and try something new today - because Sainsbury's now looks an even better bet.
Our recommended article for today
For centuries, gold has been the traditional hedge against economic crisis, inflation, or currency collapse. But there's one asset that can outperform it, says Chris Mayer. Here, he looks at the impressive returns you can get from agricultural land.
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