Investment Column: Food for thought if you want a stake in grocers

I think Tesco might look cheap by the end of the year, so it's time to take a punt and buy

If you want to buy shares in supermarkets as well as your food, entertainment, electricals, toys, even banking and insurance, you have a problem. Your investment is going to have to run very fast just to stay still.

It is true that the supermarkets are perhaps the most defensive play in the retail sector. Their core offering – food – is something everyone has to buy. They've managed to increase their share of the shopper's pound by adding the other product lines, which they can often sell cheaper with their scale and buying power.

But it is where the shopper wants to spend that pound that is causing difficulties: namely online or in convenience stores. These are the fastest-growing parts of the supermarket business. The trouble is they aren't very fast at all when it comes to profitability.

If you have a big out-of-town aircraft hangar you can pack it full of all sorts of stuff, with relatively few staff, cheap land and rates, and easy access for your lorries. It's a wonderfully efficient form of retailing.

Convenience, with much smaller town centre stores, imposes much higher costs. So does online, where you have to fill the customer's shopping basket for them and then pay someone to deliver it to their door at a time convenient to them. Which they don't want to pay extra for.

Margins, already tightish, are going to come under pressure. Long- term, if you're looking for really exciting capital growth, you're best to look elsewhere.

However, that ignores the good bit. Supermarkets still make lots of money, enough to sustain very juicy dividend yields. They have huge property portfolios, which gives all the big groups' shares a natural floor. And notwithstanding the difficult economy and competition from discounters such as Aldi (a serious threat), people still spend a high proportion of their shopping budgets with a member of the big four.

Three of which are quoted, and all of which have recently offered trading updates. The most recent was by WM Morrison, which has been struggling. Yesterday it continued to report falling sales, down 1.8 per cent in the first quarter, though some analysts had expected worse, and the rate of decline is at least slowing.

There's been a lot of talk of some sort of tie-up with Ocado, the online grocer, and promises of setting up an online operation too. But progress has been slow. Theoretically Morrison's has a lot to shoot for. It's smaller, and so ought to be more fleet of foot than larger rivals. It has little presence in convenience, an area it has been targeting, with a lot of room for growth. Some analysts even detect signs of light at the end of the tunnel. But the shares have been run up very strongly recently and I'd like to see firmer evidence.

Morrison trades on 11.4 times forecast earnings for the year ending 31 January 2014, which implies a yield of 4.3 per cent. That makes it looks very comparable to Tesco, in terms of valuation. Tesco too has had its problems, but Morrison's would appear to be deeper, with less evidence they are being tackled. So I'd continue to steer clear, though the shares are a fair bit higher than the 268.8p at which I made the same recommendation at the end of November.

As for Tesco, I said hold at 339.6p in December, and since then the shares have put on a balmy 10 per cent. It didn't hurt that Christmas was a happy one for the chain, and calling time on its cack-handed attempt to break into the US was also well received.

Despite its problems in the UK, Tesco has something that the other chains don't have: exposure to growing markets overseas. It is dominant in the internet sphere, and its decision to spend cash rejuvenating its UK stores was the right one. While last year was one to forget financially, Tesco could fly again if the numbers fire this year, and on 11.4 times earnings for the year ending 28 February 2014, with a tasty 4.1 per cent prospective yield, it is not overly expensive for a company of its size.

Equities have done well as an asset class, and even though my local shop is a good example of what Tesco (still) needs to put right, I think Tesco might look cheap by the end of the year. So I'm going to take a punt. Buy.

The last of the big three supermarkets is Sainsbury's, making waves with its decision to take full control of its banking arm and because of speculation that the chief executive, Justin King, is thinking about stepping down. He says he's not. Good, because he's a rare CEO who might just be worth what shareholders have to pay for his services. The recent numbers were as solid as ever, with underlying profits up 6 per cent at £756m for the year to 16 March.

Sainsbury's shares are on the pricey side, although they've been winners for this column after I said buy at 331.8p at the end of November. They're about 14 per cent ahead of that now. But Mr King deserves a premium.

Sainsbury's margins are lower than rivals' but it has the best forecast yield (4.6 per cent) and doesn't have the "issues" of rivals. So hold on.

Start your day with The Independent, sign up for daily news emails
ebooksA year of political gossip, levity and intrigue from the sharpest pen in Westminster
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Sheridan Maine: Commercial Finance Manager

Up to £70,000 per annum + benefits: Sheridan Maine: Are you a qualified accoun...

Sheridan Maine: Regulatory Reporting Accountant

Up to £65,000 per annum + benefits: Sheridan Maine: Are you a qualified accoun...

Ashdown Group: Marketing Services Manager - (communications, testing, DM)

£32000 - £35000 per annum + benefits: Ashdown Group: Marketing Services Manage...

Guru Careers: Finance Account Manager

£Neg. (DOE) + Excellent Benefits: Guru Careers: A Finance Account Manager with...

Day In a Page

Homeless Veterans appeal: 'You look for someone who's an inspiration and try to be like them'

Homeless Veterans appeal

In 2010, Sgt Gary Jamieson stepped on an IED in Afghanistan and lost his legs and an arm. He reveals what, and who, helped him to make a remarkable recovery
Could cannabis oil reverse the effects of cancer?

Could cannabis oil reverse effects of cancer?

As a film following six patients receiving the controversial treatment is released, Kate Hilpern uncovers a very slippery issue
The Interview movie review: You can't see Seth Rogen and James Franco's Kim Jong Un assassination film, but you can read about it here

The Interview movie review

You can't see Seth Rogen and James Franco's Kim Jong Un assassination film, but you can read about it here
Serial mania has propelled podcasts into the cultural mainstream

How podcasts became mainstream

People have consumed gripping armchair investigation Serial with a relish typically reserved for box-set binges
Jesus Christ has become an unlikely pin-up for hipster marketing companies

Jesus Christ has become an unlikely pin-up

Kevin Lee Light, aka "Jesus", is the newest client of creative agency Mother while rival agency Anomaly has launched Sexy Jesus, depicting the Messiah in a series of Athena-style poses
Rosetta space mission voted most important scientific breakthrough of 2014

A memorable year for science – if not for mice

The most important scientific breakthroughs of 2014
Christmas cocktails to make you merry: From eggnog to Brown Betty and Rum Bumpo

Christmas cocktails to make you merry

Mulled wine is an essential seasonal treat. But now drinkers are rediscovering other traditional festive tipples. Angela Clutton raises a glass to Christmas cocktails
5 best activity trackers

Fitness technology: 5 best activity trackers

Up the ante in your regimen and change the habits of a lifetime with this wearable tech
Paul Scholes column: It's a little-known fact, but I have played one of the seven dwarves

Paul Scholes column

It's a little-known fact, but I have played one of the seven dwarves
Fifa's travelling circus once again steals limelight from real stars

Fifa's travelling circus once again steals limelight from real stars

Club World Cup kicked into the long grass by the continued farce surrounding Blatter, Garcia, Russia and Qatar
Frank Warren column: 2014 – boxing is back and winning new fans

Frank Warren: Boxing is back and winning new fans

2014 proves it's now one of sport's biggest hitters again
Jeb Bush vs Hillary Clinton: The power dynamics of the two first families

Jeb Bush vs Hillary Clinton

Karen Tumulty explores the power dynamics of the two first families
Stockholm is rivalling Silicon Valley with a hotbed of technology start-ups

Stockholm is rivalling Silicon Valley

The Swedish capital is home to two of the most popular video games in the world, as well as thousands of technology start-ups worth hundreds of millions of pounds – and it's all happened since 2009
Did Japanese workers really get their symbols mixed up and display Santa on a crucifix?

Crucified Santa: Urban myth refuses to die

The story goes that Japanese store workers created a life-size effigy of a smiling "Father Kurisumasu" attached to a facsimile of Our Lord's final instrument of torture
Jennifer Saunders and Kate Moss join David Walliams on set for TV adaptation of The Boy in the Dress

The Boy in the Dress: On set with the stars

Walliams' story about a boy who goes to school in a dress will be shown this Christmas