It’s hard to believe that supermarkets were once considered defensive shares by many investors. Since the financial crisis, though, the sector has been upended by a variety of challenges that have caused sales and profitability to come under severe pressure.
Weak consumer confidence, the continued threat of budget operators and the transition towards digital retailing have all impacted on the wider sector.
Now, though, there could be improving performance ahead. Tesco (LON:TSCO) and Ocado (LON:OCDO) may therefore have investment appeal over the long run in my opinion.
Tesco
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Last week’s results released by Tesco showed that it continues to make progress with its strategy. Cost-cutting has helped its margins to rise, with it now being on track to reach its medium-term profit goals. Furthermore, there have been continued improvements in the perception of quality and value among the supermarket’s customers. This may provide it with a wider economic moat that could prove valuable should consumer confidence remain weak.
Due in part to it being forecast to grow earnings per share by 20% in the current year, further dividend growth is expected. In the current year it is forecast to yield 3% from a dividend that is due to be covered twice by profit. Since it has a PEG ratio of 1.2, it seems to offer a wide margin of safety that could lead to improving stock price performance.
With a greater focus on innovation that includes an increasing number of new products, Tesco seems to be winning over new customers. Alongside further cost-cutting measures that are expected to be delivered, this could lead to sustained growth in the medium term that may translate into a rising share price.
Ocado
Although Ocado is listed within the ‘food retail’ sector, it is a very different company than many of its industry peers. Its lack of physical stores may provide it with a competitive advantage over the long run, with consumers increasingly using mobile apps to buy groceries online and have them delivered. The company may not experience the painful process of closing stores that could become an increasingly common sight across the global retail segment.
The company’s investment in technology has placed it in a strong position to capitalise on the growing trend towards online shopping. Agreements signed with major retailers across a range of major regions have broadened the company’s operations, and may help to reduce risk in what is a highly competitive UK grocery sector.
Of course, the recent deal with M&S is perhaps the most noteworthy agreement made by Ocado. It replaces the expiring agreement with Waitrose, and could be beneficial to both companies.
Although Ocado’s lack of profitability may continue to be its achilles heel, its increasing dominance of a variety of segments could position it for long-term growth. Alongside Tesco, the company may offer greater investment potential than the stock market is currently anticipating.
While the grocery segment has changed remarkably in the last decade, the two companies may be well-placed to capitalise on its future growth prospects.