Key points:
- The British supermarket chains used to have the highest gross and net margins globally
- Now they don’t and Tesco, Sainsbury’s and so on have suffered badly
- The question now is who will win this next round – some are betting on it being Tesco
- How to buy Tesco shares
Tesco PLC (LON: TSCO) shares have not done well over recent years. In this longer-term part of the problem has been self-inflicted – accounting scandals over the timing and size of promotional discounts and incomes for example. More of an issue for the whole sector though has been the irruption into the UK market of the discounters, Aldi and Lidl particularly.
Time was when the UK supermarket chains enjoyed some of the highest gross and net margins among the global supermarket chains. That of course left room for them to be undercut and those net margins have shrunk in lockstep with the Aldi and Lidl expansions.
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The question is though, well, what comes next? For the discounters are stating that they’re going to continue to put that downward pressure on prices. So it doesn’t seem that there’s any great space for margin increases.
On the other hand, Morrison’s is going private and that’s rarely been a harbinger of major investment. J Sainsbury PLC (LON: SBRY) has its own bid problems with Daniel Kretinsky having amassed a 10% stake. Again not a time when investments in price cuts are likely. Asda’s under that mountain of debt from the recent takeover by private equity again. There’s really only that one man left standing, Tesco.
Which is where the speculation is, in Tesco shares. If any of the major supermarket groups are going to come out on top against the discounters then it’s likely to be Tesco.
Speculation is that there will be a considerable rise in the dividend at the year-end (in April) and the possibility of substantial share buybacks. All that private equity interest in the other supermarkets does mean that management won’t want to be sitting upon any pile of cash that might be generated. And Tesco does look to be generating free cash flow at a rate of 8%.
So there’s a story about the upside of Tesco there. On the other hand, there is the downside. Tesco shares have fallen 2% this morning on the back of the Q3 and Christmas trading update. These are not glorious numbers, sales up 2.3% (including Christmas, 2.4%) but then as Tesco itself points out this is building on the very strong results of a year ago. Lockdown did boost sales at those places that were allowed to stay open. There is also that insistence from Aldi and Lidl that they’re not going to give up on the pressure on margins across the sector.
The general market feel seems to be that if anyone among the large supermarkets is going to win here it’s going to be Tesco. So that’s the positive – but on the negative, it’s not certain that anyone is going to win, is it?