Buy, hold or sell: Sainsbury's, Tesco and Morrisons
Now, Goldman Sachs has decided there's only one way the big listed three can start growing profits again.
"Our analysis of the UK grocery industry suggests capacity exit is the only viable solution for a return to profitable growth," says Goldman. Forget price cuts; anything Morrisons, Sainsbury's or Tesco can do, the German discounters can do better.
Why? Well, Aldi UK's lease adjusted return on invested capital (ROIC) jumped from 2.6% in 2010 to 10.1% in 2013. That compares with Goldman's estimates that the three UK-listed grocers have seen their returns slump from 10.5% to just of 7% in 2014. Clearly, Aldi and Lidl have the firepower to keep undercutting the big stores.
Goldman says: "This suggests that any price initiatives will be matched or exceeded by the discounters and is why we believe a broader price war is unlikely. We therefore think the only way to protect returns is to cut invested capital.
"By exiting underperforming stores, we believe the UK grocers would improve their returns through cutting the asset base while also improving profitability. We believe they need to cut invested capital c.20% to return to the c.9% lease adjusted ROIC they earned in calendar 2013."
And the domestic retailers had better shape up. Goldman predicts that channel shifts to convenience and online stores is structural and its analysis suggests that large stores will see a like-for-like compound annual growth rate to 2020 of minus 3% if no further competitive, or strategic response is made. "On our estimates, negative leverage through core assets drives a 60% fall in the listed three's operating profit through CY13-17E."
And Goldman thinks industry consolidation, while at an attractive valuation is ideal, is made unlikely in the short term because of regulation "…and therefore capacity exit from the largest store operators appears to be the only solution. Alternative use property valuation suggests no support at current share prices".
Buy, hold or sell?
Sainsbury's (SBRY): SELL
"As Aldi and Lidl gain increasing traction with the middle classes, and their higher ROICs allow them to continue to lead on price, we believe Sainsbury's will struggle to reverse negative sales growth and thus negative leverage. (We) believe dividends will continue to fall beyond FY15E. Our 12-month price target is 155p, implying 42% downside."
Tesco (TSCO): SELL
"We believe structural shifts away from large stores means over-spacing and not price is its biggest problem. Our SOTP continues to show downside and we remain Sell rated with a 12-month price target of 155p." Its target was 250p previously.
Morrisons (MRW): BUY
"We model the largest price investments and the deepest volume declines at Morrisons, but with cost savings and asset disposals we still believe it will remain the least levered (lease-adjusted) grocer, with the most visibility on cash generation.
"Despite this, MRW trades on an average 6.6% dividend yield over the next three years (Bloomberg consensus) vs. Sainbury's on 4.8% and Tesco on 3.0%. We see a deep value opportunity here and as a result upgrade to Buy from Sell on a relative basis with a 12-month price target of 207p."
This article was written for our sister website Money Observer
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
A catch-all phrase that can range from assessing the price of a property or vehicle before offering it for sale or the net worth of assets in an investment portfolio to the prices of shares on a stock exchange.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.