Tesco is way ahead of the pack - but for how long?
By
Euan Stuart Dec 12, 2005
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The UK's supermarket wars are showing no signs of abating. In fact, the battle is becoming more savage by the week as the players work to out-position each other and engage in brutal price wars. Still, however you look at it, there's no doubt who is coming out on top: Tesco. Most retailers are 'squealing about a slowdown in the market', says Breakingviews.com. But Tesco has just reported total UK sales up more than 11%, with like-for-like sales (excluding petrol) up nearly 7% in the 12 weeks to 21 May. This strong performance puts Tesco on track to increase its profits by more than £300m this year, the same amount of profit that J Sainsbury, its nearest quoted competitor, is set to make in total, according to Andrew Fowler of house broker Merrill Lynch.
Over the same period, Sainsbury which is perceived to be recovering after a disastrous few years saw only a 1.3% rise in like-for-like sales, something, says Breakingviews.com, that proves Tesco is not just 'being lifted by a rising tide'. Instead, it's doing better than other supermarkets thanks to a simple-sounding strategy: it has invested all its cost savings into lower prices, allowing it to increase volumes rapidly, 'which in turn has allowed it to reap even greater scale benefits'. The opposition just doesn't seem to be able to keep up. Sainsbury has been the obvious loser in terms of market share, but Wm Morrison is suffering too. Sir Ken Morrison, the group's chairman, is facing a challenge that may end up with him losing control of a lifetime's work, says Henry Tricks in the FT. The directors have been forced to push the firm into announcing a string of profit warnings and deputy chairman David Jones who has been at loggerheads with Morrisons for months has finally persuaded Sir Ken to accept on to the board three new non-executives of the four proposed. All this has shaken the Bradford-based supermarket chain to its core, with staff morale 'plummeting'.
Sir Ken insists the problems are short term, says Jenny Davey in The Times, and that, once remaining Safeway stores now owned by Morrisons are converted, the group will 'get back to its tradition of strong, steady growth'. He may be right, but odds are that, after the 'shenanigans' of the last year, investors will want to see more than just promises before they buy again. Don't hold your breath for any proof though, says Simon Caulkin in The Observer. The tide may well be turning against the supermarket model. A report by the New Economics Foundation recently accused the big chains of turning Britain's high streets into 'clones' and it is clear that consumers are starting to notice the lack of local produce and disappearance of small local shops.
No business model lasts for ever, as food and retail companies constantly illustrate to 'remarkable' effect. Think of the cases of McDonald's, Woolworths and Marks & Spencer, for example. All have run foul of changing customer taste and should offer a firm lesson to today's food retailing giants Tesco included that they should never become so focused on short-term profits that they fail to read the signs of supplier and customer discontent. Friends of the Earth, with the support of 22 MPs, are calling for an Office of Fair Trading inquiry into the monopoly of Tesco in the UK grocery market, and even the firm's shareholders recently criticised the supermarket chain for their treatment of their British suppliers. Add this to the general slowing of consumer spending across the board and you have to wonder for how long even Tesco can keep growing.
Two supermarkets to snap up and one to steer clear of
It is tough to find a UK fund manager who is anything but underweight in the retail sector as a whole. But almost all of them own shares in Tesco. The shares have risen 50% over the past five years, but even now, says Camilla Palladino on Breakingviews.com, the market isn't really giving it enough credit. It is piling on space here and abroad and overall return on investment is rising. Yet it trades on a p/e of only 17.7 times only a modest premium to the likes of Metro and Carrefour in Europe, despite its much faster growth. Hilary Cook of Barclays Stockbrokers is also a fan, pointing out that Tesco is the UK's largest online and home-delivery retailer. Still, J Sainsbury has its fans too, says Sophy Buckley in the FT. It struck a confident note last week with its second successive quarterly sales rise, something that chief executive Justin King says puts the firm ahead of schedule in his three-year recovery plan.
One to avoid though is Wm Morrison, says Jenny Davey in The Times. The shares have fallen 22% since last November and would have fallen further were it not for the group's property portfolio. Yet the shares still trade on a p/e of more than 20, making them more expensive than those in the significantly more successful Tesco. Investors should 'shop elsewhere'.
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