All three of the UK’s big listed supermarkets have shared their Christmas trading updates over the last week or so. I don’t own any UK supermarket shares currently, but all three of these firms offer above-average dividend yields.
As an income investor, I wouldn’t mind owning a slice of these defensive businesses. The only problem is that they all seem pretty similar at first glance. I’ve been digging deeper to decide which one I’d buy today.
Covid-19 growth – what’s next?
All three supermarkets saw demand surge last year as a result of the pandemic. This continued over the Christmas period, when they each posted sales growth of 8%–9%.
This is unusual, to say the least. But with the hospitality trade closed and more shoppers choosing to buy online, supermarkets have been the only game in town for many households. However, these conditions won’t last forever. If I’m buying shares now, I need to think about what might happen next.
Interestingly, each of these three has a different growth strategy. I think this could become more important over the coming years.
Integrating Argos stores into J Sainsbury (LSE: SBRY) supermarkets has worked well during the pandemic. Customers have been able to shop a much wider range of goods for in-store collection or delivery. Will Argos continue to compete successfully against rivals such as Amazon and Currys PC World after the pandemic? I’m not sure.
Over at Tesco (LSE: TSCO), I’ve long admired the group’s decision to acquire wholesaler Booker in 2018. This business has stronger growth and higher profit margins than UK supermarkets. Although Booker’s sales growth was held back last year by widespread closures in the catering industry, I expect a strong recovery when the UK returns to normal.
What about Wm Morrison Supermarkets (LSE: MRW)? The group’s growth plans have continued this year without hitches. The Bradford-based retailer has expanded its wholesale business by supplying more convenience stores, while also supplying Amazon’s online grocery service. Morrisons says its online business is already profitable. I expect steady growth to continue.
For me, Morrisons is the winner in terms of post-Covid growth potential, with Tesco in second place.
Which UK supermarket share is cheapest?
Until quite recently, Sainsbury’s shares looked cheaper than Tesco or Morrisons. But the orange-topped supermarket has enjoyed a strong run up as it became clear the business was performing well.
There’s no longer much difference between the three shares in terms of valuation. All three trade on around 13 times forecast earnings for 2021–22.
Sainsbury’s forecast dividend yield for the year ahead is still a little higher than the others at 4.4%. But the group’s profit margins are still much lower than either Tesco or Morrisons. Although Sainsbury’s is cheap, I’m not yet convinced by the group’s turnaround.
Tesco looks a safe bet for income, and the firm’s 3.8% forecast yield is slightly ahead of the FTSE 100 average. But now that it’s sold most overseas operations, I think growth is likely to be quite slow.
My pick of the UK supermarket shares is Morrisons. I think the group’s low-cost approach to wholesale growth makes sense. The shares look reasonably priced to me – this is the stock I’d buy.
