Why Lidl's success would make me dump J Sainsbury plc

J Sainsbury(LSE: SBRY) posted a third-quarter update Wednesday, saying full-year underlying pre-tax profit should be a little ahead of the current consensus.

Total retail sales (excluding fuel) for the 15 weeks to 6 January grew by 1.2%, and on a like-for-like basis by 1.1%. Grocery sales were up by 2.3%.

Chief executive Mike Coupe said: "We delivered an excellent operational performance across the Group, with great availability, strong customer satisfaction scores and our lowest level of waste ever at Christmas."

So why would I not buy Sainsbury shares? Modest rises like these must be tempered by the inflation levels of the past year -- though Mr Coupe reckons food price inflation should start to ease over the next six to nine months.

Trounced by Lidl

And on the same day, Lidl reported not just an improved December's trading, but a record one with a 16% rise in sales -- and among the figures for Christmas comestibles, I was particularly struck by the chain's sales of 600 tonnes of Brussels sprouts.

Sainsbury's online sales were impressive, showing an 8.2% rise, and that's where it does have an advantage over Lidl and Aldi (along with its other sector rivals like Tesco and Asda). But although that's a growing sales avenue, it's still very competitive and it's very easy for shoppers to chop and change between online suppliers.

Sainsbury shares picked up a little on the news, to 252p, which puts them on a forward P/E of 13.5 based on full-year expectations -- though a fall in EPS is predicted. With a return to EPS growth pencilled in for the following year, we'd see that multiple drop to a little over 12, and dividend yields look pretty decent at around the 4% to 4.5% level (and well covered by earnings).

But we're looking at a very competitive business with tightening margins as we continue in what's increasingly becoming a tough economic period with little or no real wages growth. If I wanted to invest in the sector at all, I'd go for the best performing stars -- but I can't, because they appear to be Lidl and Aldi, so I'm out.

Morrison too

Wm Morrison Supermarkets(LSE: MRW) is in the same boat after its trading update on Tuesday revealed an even better 2.8% rise in like-for-like sales over the 10 weeks to 7 January.

And forecasts suggest a turnaround is in the making here too, ahead of Sainsbury. Morrison actually recorded a 40% improvement in EPS for the year to January 2017, though that did come after a four-year slump, and earnings still came in at less than half of 2013's figure.

Still, there's a 10% rise expected for the current year, followed by a further 7% next year, and the dividend recovery is expected to continue with yields of 2.8% and 3% respectively on today's 229p share price. But forward P/E multiples, at 19 for this year and 17 next, look too high to me.

The squeeze on Morrison from Lidl and Aldi can surely only get tighter, as shoppers are responding to their reducing spending power by focusing on low prices -- and Lidl is planning to open one new store a week in the coming years, while Morrison is still thinking about cost savings.

Wm Morrison does have a hand in the expanding online shopping business -- I've used it, and it's good. But we've got Amazon muscling in on that space too these days.

Better than supermarkets

Supermarket shares, especially Tesco, were for a long time a staple of many an investor's long-term portfolio. And rightly so, at the time. But I reckon they have been well overtaken in the long-term cash stakes by a number of other big names, which are leaders in their sectors.

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Alan Oscroft has no position in any shares mentioned. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. The Motley Fool UK owns shares of and has recommended Amazon. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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