Which supermarket share should you buy?

RELATED QUOTES

SymbolPriceChange
HIGHSTREE.BO39.250.00
BRW.L331.80+6.20
TSCDY14.55-0.22
SBRY.L314.00-6.60
TSCO.L289.70-4.10

Warren Buffett and Neil Woodford have backed Tesco (Other OTC: TSCDY - news) and Morrisons. But what about Sainsburys? We compare the retailers.

Death and taxes may be the two most widely quoted certainties in life, but the need to eat is just as compelling. The shares of supermarkets, therefore, offer a certain appeal to investors in times of economic uncertainty. Add in the attraction of dividend yield of around 4pc and it's easy to see why some of the shrewdest investors - such as billionaire Warren Buffett and star fund manager Neil Woodford - are backing British supermarkets.

But even though these stocks have solid and reliable revenues, it is not always a smooth ride as we explain below.

The trick for investors is to work out which companies have the cheapest shares relative to their profits. Dividing the share price by profit gives you a price to earnings ratio or P/E ratio. The lower the P/E ratio, the cheaper the stock.

Alongside each of the shares is a recommendation of "buy", "sell" or "hold". These are majority calls based on the opinions of more than 20 global analyst rankings collated by Bloomberg.

= =

= TESCO: BUY =

Yield: 3.98pc

P/E Ratio: 9.1

Tesco's success is well documented. Sir Terry Leahy, a former shelf-stacker, was credited with turning the company around and making it the third largest retailer in the world, expanding internationally into emerging markets and cleaning up on the internet. Around £1 in £8 spent on the High Street (BSE: HIGHSTREE.BO - news) , it was reported last year, was being spent at Tesco.

But its feted status has slipped since Sir Terry Leahy stepped down as chief executive in March 2011.

"The new management has had to take a step back to move forward," said Clive Black, retail analyst at Shore Capital. "They have had to make UK shoppers believe that they are on their side rather than just after profits."

Tesco paid the price for expanding internationally too fast and has since withdrawn from Japan and America. The group is now entering a new phase, say analysts, focusing on making existing assets work.

The shares have high profile backing - last January Mr Buffett, the Sage of Omaha himself, increased his stake in the supermarket from 3.21pc to 5.08pc, buying when the stock was bombed out at 323p. There have been some blips since then - last month's horse meat scandal knocked £300m off the market value in just one day - but the shares have staged a decent recovery, reaching as high as 385p earlier this month.

A spree of recent acquisitions high street restaurant chain Giraffe, "artisanal" coffee shop Harris + Hoole, and the Euphorium Bakery chain suggest a new found confidence from the new chief executive, Philip Clarke.

Nicla Di Palma, retail analyst at Brewin Dolphin (LSE: BRW.L - news) , said while consumer perception of the company may have deteriorated, Tesco having 1,487 Express stores - two thirds of the total - was a plus.

"After underinvesting in the UK for a while, the company is moving as fast as possible to catch up after a long period of laziness. It has refreshed around 3,000 out of 8,500 of its own brand products so far. The same can be said for the stores," she said.

She adds that Tesco is the only one of the three quoted UK supermarkets pursuing an international strategy. She said: "While both Japan and the US have been less successful than hoped, we believe that there is the potential for good growth in Korea, Thailand and Central Europe where Tesco (LSE: TSCO.L - news) benefits from a good network of stores and distribution infrastructure."

= J SAINSBURY: SELL =

Yield: 4.35pc

P/E Ratio: 9.5

Analysts argue that Tesco took its eye off the UK market during its international foray and J Sainsbury has successfully exploited that.

The shares have beaten Tesco's over two years, rising by 10pc compared to a 3pc fall for its rival. This week, they hit a two-year high of 378p.

It is the only supermarket to have both grown its market share and outperformed its competitors on sales growth, according to Ms Di Palam. But Sainsbury (LSE: SBRY.L - news) 's also has one of the lowest profit margins. But she adds that the management, under well regarded chief executive Justin King, had successfully improve Sainsbury's as a trusted supermarket.

It is also the highest yielding supermarket paying out 4.35pc income this year - and plans to increase its dividend every year, as it has done in the past five years.

"Justin King has successfully negotiated the credit crisis," said Shore Capital's Mr Black. "Sainsburys is a steady, staid stock which we expect to continue to trade at between 330p and 380p for the foreseeable future. We think investors should hold the share simply for the dividend."

= MORRISONS: SELL =

Yield: 4.28pc

P/E Ratio: 11

Morrisons was a highly successful, highly regarded regional supermarket but some suggest an ill-thought out rebranding drive has caused the stock to lose its way.

Poorly received store conversions and a total lack of online presence have meant that it has fallen behind its rival retailers.

Morrisons, say analysts, is "falling between two posts": trying to move upmarket has put off its core customer but also failed to capture the attention of the aspirational shopper. "We love this stock but we have to focus on whether a stock will make investors money or not, and for us Morrisons is a sell," said Mr Black. "The truth is, lemongrass and cupcakes simply don't sell in Barnsley."

Ms Di Palma said 2013 was a tough year for Morrisons, which is over-represented in the North : consumers there have felt the pinch from the recession more than those in the South. She says that it also has too many large stores when consumers are moving to convenience, online and to mid-sized discounters like Aldi and Lidl.

Morrisons will have a mere 100 small stores by January 2014 and in the same month it will start selling online, but the share price may not reap the benefits for at least two years. In contrast, Tesco went online in 1997. "We will revisit the stock in around nine months time, when it may have hit the bottom and become a buy opportunity," said Mr Black. "But for now it is a sell."

Not everyone is ready to completely write off the retailer however, Invesco Perpetual's Neil Woodford, one of the UK's most highly-regarded fund managers, upped his position in Janary to 7.7pc, having dumped his Tesco shares at the beginning of 2012.