The outlook for the supermarket sector continues to be challenging. Inflation has moved ahead of wage growth and this could cause a squeeze on real disposable incomes. The effect of this on shopping habits could be negative, with shoppers likely to become increasingly price-conscious. Supermarkets may be left with a choice as to whether lower prices to prop up sales, or accept lower sales and more stable margins.
The idea that Sainsbury’s (LON:SBRY) and Morrisons (LON:MRW) could be appealing turnaround stocks may therefore be difficult to envisage. However, with the two companies having what appear to be sound strategies, their share price performances could be surprisingly impressive in the long run.
Economic outlook
While inflation may be ahead of wage growth today, the prospect of a significantly higher rate of inflation may be less likely than previously forecast. The Bank of England has hinted that an interest rate rise may be ahead in the short run, and this could strengthen the pound and help to cool inflation to some extent.
The prospects for retailers such as Sainsbury’s and Morrisons, though, remain difficult. Concerns about the Brexit process may remain high and this could offset at least part of the impact on the pound of an interest rate rise. Further, confidence among consumers may have improved marginally last month, but it remains close to its lowest point since the EU referendum. Therefore, even if inflation is kept under control, consumer spending may deteriorate in the short term.
Strategies
As was the case following the financial crisis, Sainsbury’s and Morrisons may suffer financially from a difficult consumer outlook. However, this may be offset by the strategies they are currently pursuing, both of which could boost their long-term financial outlooks.
Morrisons has sought to develop capital-light growth opportunities. For example, it has resurrected the Safeway brand and will supply a range of products under the brand to convenience stores. It has also partnered with Amazon Fresh to leverage its status as a major food supplier. And with efficiency savings being delivered and net debt moving lower, it appears to be capable of improved financial performance.
With efficiency savings being delivered and net debt moving lower, Morrisons appears to be capable of improved financial performance.
Sainsbury’s is pursuing a riskier strategy. Its acquisition of Argos means it has increased its exposure to consumer discretionary items, which could be harder hit by declining consumer confidence. However, with synergies and cross-selling opportunities, the deal could provide a catalyst for the company’s earnings in the long run.
Outlook
Both companies are forecast to post an increase in EPS in the next financial year. Sainsbury’s is expected to record a rise in EPS of 13%, while Morrisons is due to hike its earnings by 7%. Given that the former has a P/E of 11 and the latter has a P/E of 21, Sainsbury’s could be viewed as the better buy. However, with an arguably more defensive business model and lower-risk strategy, Morrisons may also have investment appeal.
Clearly, the short run may be tough for both stocks. But with their current strategies they could prove to be surprisingly effective turnaround stories in the long run.
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