Tesco vs Morrison

Published in Company Comment on 17 April 2009

These two supermarkets offer investors similar value, but their business models are made up of rather different ingredients.

Would-be investors in supermarkets have an interesting choice. Unlike many sectors where representation is limited -- technology, say, or luxury goods -- the UK market stocks a decent variety of large general retailers, ripe with promise and sometimes boasting juicy dividend yields.

FTSE 100 investors can choose between Tesco (LSE: TSCO), Morrisons (LSE: MRW), Sainsbury (LSE: SBRY) and Marks & Spencer (LSE: MKS) if they want exposure to the sector.

Like their stores, these supermarket companies are superficially similar, yet each has a different story to tell investors, and over 5-10 year periods their performances are quite distinct.

Each offers subtly different business models, histories -- Sainsbury is now a recovery story, for instance, whereas Tesco is all about expansion -- and even alternative ways to play the wider economy.

Share fight!

Here though I'm going to compare the investment merits of Morrisons and Tesco.

Tesco is the UK's retail giant that has a 30% market share -- almost three times that of Morrisons, which became the fourth largest UK supermarket chain after merging with Safeway in 2004.

An insight into how the market views these supermarkets can be gleaned from their share price action over the past year:

Company12-month performance
FTSE 100-31.5%

Both their share prices are down by about the same amount, but they have comprehensively beaten the FTSE 100, which has been hard hit by falling financial and resource companies. Traditionally, supermarkets are defensive stocks to own during a slowdown.

Last Autumn though, Tesco was trailing by a greater amount though as it was felt it would suffer more from the downturn in the economy. For example:

1) Tesco is more reliant on non-food sales than Morrisons. In a depression we might still buy bread and milk, but the £8b we spent on laptops, flat screen TVs and other non-food products at Tesco during its last full financial year are much more vulnerable to a deep slowdown.

2) Industry analysts reckoned Tesco shoppers were switching to Asda, Aldi -- and Morrisons.

3) Tesco is a truly international business -- it has more retail floor space outside of the UK than within in -- with substantial interests in recession-afflicted Eastern Europe, and thus more exposure to any derailment of global trade.

4) Tesco was also hit by a rights issue rumour. SocGen suggested the supermarket might need to tap shareholders for £2 billion if it was unable to refinance its debt due to the frozen credit market.

Tesco since revealed some decent Christmas trading results, thanks in part to booming international business. As a result, its share price has made up some ground in the last few months -- but key differences between the two companies had been revealed.

Where next for Morrisons?

Morrisons released its latest annual on 12 March. Turnover was up 12% to £14.5b and an extra 550,000 people were said to be shopping at its stores each week, helping fuel a 50% surge in sales of its revamped Value range.

At 248.5p, with underlying earnings per share of 16.7p the company is on a historic P/E of 14.8 and dividend yield of 2.3%. The forecast P/E is 13.8.

Morrisons' debt situation looks very manageable, with net debt at £642 million equating to gearing of 14%. Interest is covered a very comfy 42 times by profits.

Over the next year Morrisons plans to add some 850,000 sq ft of floor space to its business and another 500,000 sq ft the year after. Its plan is to reach out to an estimated eight million UK households who aren't within a 15-minute drive of a Morrisons store.

Where next for Tesco?

Tesco reports its latest full-year results on 21 April. It's expected to report turnover up £2b to £54b, with record annual profits of £3b. Priced at 330p, Tesco is on a historic P/E of 12.2 and dividend yield of 3.3%. Its forecast P/E is 12.1.

Tesco's debt situation isn't as rosy as at Morrisons, however. Assuming debt is reported next week at around £8b, gearing will be over 30%. This is manageable, given Tesco's cash flow and its property portfolio, which the company values at well over £20b, but it's still a concern while the financial turbulence continues. Tesco's pension deficit is also large, and likely to rise to well over £1b.

In terms of the future, Tesco will emphasise its international operations next week. With UK like-for-like sales growth likely to be modest, the company will talk up its new retail banking plans, which could see 30 banks in its stores by the end of the year.

Which is better value?

Based on the quick analysis above, Tesco looks a little cheaper, with a lower P/E ratio and a higher yield.

If I was going to make a new investment in either company though, I'd want to drill down deeper into its operations, looking more closely at cash flow and margins, for instance.

What is clear however is that the two supermarkets offer very different opportunities to investors.

Morrisons looks a little like the Tesco of a decade ago. If you buy its shares, you're betting on it continuing its successful nationwide expansion, and on it being able to keep squeezing out smaller competitors while stealing market share from the bigger boys -- just as Tesco previously did with Sainsbury.

Morrison’s debt position is reassuring, and its reliance on groceries makes it a more defensive stock in the traditional way of supermarkets.

Tesco is a different beast. With further UK growth very limited, buying its shares means backing its much-admired managers to do something few British companies have ever achieved -- ongoing and profitable international expansion -- while finding new ways to at least tread water at home. International archrival Carrefour has just announced its first quarterly sales drop in six years, so the risks for Tesco are clear.

In my view Tesco is the more bullish purchase, even though it's rated slightly cheaper according to P/E ratio than Morrisons. If the recent rally in the stock market continues and banks further relax their lending, Tesco's debt position will become much less of a worry and its pension deficit will begin to recede.

I'm fairly optimistic we could be through the worst for the capital markets -- though probably not for the economy -- so along with Warren Buffett who bought the shares in 2006, I hold Tesco.

More on the retail sector:

Owain holds shares in Tesco.

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jonesjeff 18 Apr 2009 , 9:39pm

The service in my local very large Tescos is going to the dogs. I find a lot of things I want to buy are not on the shelves.
In fact, that store's just like Sainsburys were when they were struggling a few years back. If this is quite common in their other stores, then I would avoid the shares.

rickyman49 21 Apr 2009 , 4:01pm

I bought morrissons shares when they dropped aftertaking over safeway.After a couple of years they doubled as I thought they might.I have agood local Morrisons which has developed enourmously over the last few years. Fresh bread ,fish veg and meat as good if not better vlaue than Tesco. I think they concentrate on freshness of basics and give excellent service now for the average family. For better quality I go to Booths (similar to Waitrose) in North of England only.Tesco is too big for its boots and could over-reach itself as they did in USA.Also have many temporary staff who dont care.You need to feel comfortable with the company when you invest.

bojotools 21 Apr 2009 , 5:15pm

Tesco seem to train their staff to be confrontional. I hade a major fall out with my local store a couple of years ago when shopping with my then 14 year old son as the assistant overheard me say to a friend that we were going to try a speciality beer I was about to purchase when we got home. This was totally legal, none of Tesco's damn business and totally outside the 'Proxy Purchase' law. My son and I look like peas in a pod and were well known to the store staff as father and son. The resulting fuss and embarassment (with no apology) stopped me shopping there for a couple of years. First time I decided to try them again, an assistant managed to pick an argument with a group of young adults (clearly mid 20's) - because they had just talked to another young adult who they deemed to need ID because the older shoppers were purchasing alcohol. A loud argument ensued and the assertion of a watching staff member that he knew the person who's ID they queried (and he was 22) was totally ignored. The angry 22 year old came back a few minutes later with his valid ID but I doubt that he will be buying Tesco shares any time soon. If I lived in the USA I would have sued Tesco for the experience I had, but it wasn't worth the hassle in this country. I hope that their operation in the USA fails miserably. Asda staff are certainly better trained and happier in their jobs.

shikisha 09 May 2009 , 10:43am

We shopped at Morrisons in Reading for the first time recently - there's none within easy reach from home. It was far more welcoming than either Tesco or Sainsburys, and I think there is a simple reason. We felt we were still dealing with a grocer - Mr Morrison - who knows the vital power of face-to-face relations with the customer. The other two are run by remote CEOs, boards and the balance sheet. I once made a comment to a Sainsburys assistant - she said it's obvious, as we've been saying for weeks, but they don't listen, we just have to jump to orders from on high. Head office remotely controls every detail, turning the staff into cogs in a machine. The Morrison staff, like those of Waitrose, give a much more direct personal service. Let's hope Morrisons don't expand out of character. Aldi and Lidl work well because there are virtually no staff beyond the cashier, and they are of a human scale. It's self-help rewarded by cheap prices,in some cases for high quality products, oftern hald the price of the usual international brands.
It suggests that while it's still human, Morrisons will do better that their giant rivals, who may be crippled by the cost of reckless expansion.

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