UK supermarket shares: “Things are likely to get worse before they get better”

29th September 2014

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Sainsbury’s is set to update the market this week but some experts believe investors should be steering well-clear of the UK’s troubled supermarket sector.

As a result of far tougher competition in the food retailing industry Sainsbury’s has already witnessed its shares tumble by 37% over the past 12 months, while over the same period, Morrison is off 40%.

Tesco, presently under the microscope for overshooting its half-year profit forecast by a spectacular £250m has endured an even steeper 47% fall.

For some commentators, it is time to get out. Chris Beauchamp, market strategist at IG Group, believes investors looking for a quiet time should avoid investing in supermarkets as he believes “things are likely to get worse before they get better”.

He said: “The old cliché in financial markets is that things that are cheap tend to get cheaper. This has been clearly demonstrated in the UK supermarket sector in recent months.

“Tesco has gone from bad to worse, while Morrisons has all but ruled itself out as a viable investment thanks to its long-term turnaround programme that is aimed squarely at the budget supermarkets that are snapping at its heels. Sainsbury’s trading statement this week could see that supermarket put on the naughty step as well – if trading is revealed to be weaker than expected we could see pressure on the dividend once again.”

But within all of the troubles, it is supermarket dividends which will dominate shareholder attention.

Beauchamp explained that while FTSE 100 currently has a yield of 4.74%, a number that has been steadily rising in recent years, in comparison Sainsbury’s has a current yield of 6.98%, far above the broader index with coming years expected to see the yield drop to 6.29% in 2015 and then 5.89% in 2016. For its part, Morrison looks even shakier on the yield front, at 7.82% for the current year, 8% in 2015 and 6.4% in 2016.

“At least Tesco has bitten the bullet and cut its payout, with the current 7.82% yield forecast to drop to 2.86% and 3.23%. At this stage, it is not much of a risk to suggest these lofty yields will lead to a dividend cut at both Sainsbury’s and Morrisons – they would be following Tesco’s lead, and while income investors would not be happy, a cut to the payout is a prudent course given that trading and margins are still expected to come under pressure,” asserted Beauchamp.

He added: “It is probably not too daring to suggest that investors in supermarkets should be prepared for years of lower profits and falling sales, while the prospect of dividend cuts should make income hunters tremble.

“For investors looking for a quiet time, the supermarkets are clearly not the place to be. Rights issues to provide more cash are a possibility too, especially if a real price war begins. The sector is still a playground for the shorters, not the value hunters.”

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