The supermarkets have put in a strong performance so far this year. The FTSE 100 has struggled to make any headway, but Tesco(LSE: TSCO), Sainsbury's (LSE: SBRY) and Morrisons(LSE: MRW) have soared higher by 25%, 14% and 29%, respectively. Yet all three stocks remain well down from their all-time highs. Could they be on the cusp of a spectacular recovery?
Tesco once had around 33% of the UK market, but its slice is now down to 28%, as low-price rivals Aldi and Lidl have made relentless progress. It remains the super-heavyweight with nearest competitor Sainsbury's having just 16.4% of the market. But will the UK's number one see its market share further eroded, or can it fight back and thrive once again?
In France, Carrefour was hit by competition earlier than Tesco, and its response looks the model for the UK firm. It brought prices down, not to Aldi/Lidl levels, but enough to entice customers back with a balance of value, range and service. It's proved a successful strategy and the shares have made a big recovery over the past few years.
Tesco has been sowing similar seeds and there are signs of green shoots. The Welwyn Garden City firm's annual results earlier this month showed improving trends across the board in the final quarter of last year. Analysts expect earnings to more than double this year, followed by a 35% increase next year, bringing a high price-to-earnings (P/E) ratio down to a reasonable 18. It's early days, but the shares could continue to march higher if a Carrefour-like recovery unfolds.
Sainsbury's was the last of the Footsie supermarkets to feel the effects of competition in the sector on its top and bottom lines. While analysts forecast strong earnings recoveries this year and next from both Tesco and Morrisons, City number crunchers expect Sainsbury's to lag its rivals. A fall in earnings of 6% is pencilled-in for the financial year ending March 2017, with a meagre 2% rise the following year.
Sainsbury's forecast P/E of 13.5 compares favourably with the valuations of Tesco and Morrisons. However, recovery at Tesco and Morrisons has taken longer than analysts initially expected, and it remains to be seen whether that will prove to be the case with Sainsbury's. The acquisition of Argos, if it goes through, adds additional uncertainty, and I see this as one to watch for the time being.
Morrisons is the smallest of the three, with a market share of 10.5% so you'd expect it to be the weakling and to really struggle for profits in a competitive environment. However, the Bradford firm has advantages over its rivals. It has a strong freehold property base, so doesn't have anything like the rent bills of Tesco and Sainsbury's. And it has a large manufacturing business, so it's earning a margin both as a producer and a retailer.
Analysts are forecasting earnings growth of 44% this year, followed by 10% next year, putting Morrisons on a P/E of 17, compared with Tesco's 18 and Sainsbury's 13.5. As a general rule I'm less keen on investing in a company that's making an acquisition than on a potential bid target, and Morrisons appears a credible takeover target. However, it's the forecast earnings recovery that appeals, with the potential of an offer for the company merely a bonus.
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G A Chester 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.