Should I Buy Tesco or Wm. Morrison Supermarkets?

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LONDON -- The U.K.'s supermarket chains have become popular investments with income and value seekers in recent years, thanks to their modest valuations and attractive dividend yields.

However, although these retail giants are attractive investments, they aren't without their own challenges, so in this article I am going to compare Tesco  (LSE: TSCO  ) (NASDAQOTH: TSCDY  )  and Wm. Morrison Supermarkets (LSE: MRW  )   (NASDAQOTH: MRWSY  )  to see which looks the better buy today.

Tesco vs. Morrisons
I'm going to start with a look at a few key statistics that can be used to provide a quick comparison of these two companies, based on their last published results and current share prices:

  Tesco Morrisons
P/E ratio 21.1 10.7
Dividend yield 4% 4.2%
Operating margin 3.4% 5.2%
Price-to-book ratio 1.8 1.3

Tesco's P/E ratio of 21.1 reflects the restructuring costs and impairments it has accounted for in this year's results. Excluding these, and focusing on Tesco's preferred measure of underlying profit from continuing operations, Tesco has a trailing P/E of 10.1, almost the same as Morrisons'.

The companies' operating margins also tell an interesting story. If you look in Tesco's results, it claims an overall trading margin of 5.3%, which is almost identical to Morrisons'.

However, Tesco prefers to report its trading margin excluding the accounting cost of its Clubcard loyalty program, which was 572 million pounds last year. Once you factor this cost in, Tesco's operating margin falls to just 3.4%, which shows how its generous use of discount vouchers is having a significant impact on its profitability.

What's next?
Are the trends we identified above about to change, or should we expect more of the same?

Analysts' forecasts are notoriously unreliable, but FTSE 100 companies generally get the benefit of the most comprehensive analysis and tend to deliver fewer surprises than smaller companies.

With that in mind, let's take a look at some forward-looking numbers for Tesco and Morrisons. These apply to the companies' 2013/14 financial years:

  Tesco Morrisons
Forecast P/E ratio 11.0 10.9
Forecast dividend yield 4.2% 4.4%
Forecast dividend growth 3.3% 6.8%
Forecast earnings growth -2.7% -2.2%

These figures, which are based on the companies' guidance figures and analysts' forecasts, exclude any further restructuring costs for Tesco. Morrisons' dividend is expected to grow by twice as much as Tesco's, but both firms currently offer a similar forecast dividend yield.

Finally, earnings per share are expected to shrink slightly for both companies, probably as a result of falling profit margins and rising costs, rather than falling sales.

Which share should I buy?
I think that both companies make attractive purchases at the moment, but I'm tempted to stick with Tesco (I'm already a shareholder) because of its size and far larger online and convenience store businesses -- two major growth areas.

Morrisons is planning to launch a home delivery service in partnership with Ocado by the end of Jan. 2014, but it's too early to say how successful or profitable this will be.

The other aspect of Tesco's business I really like is Tesco Bank. Although it only generated 1 billion pounds in revenue last year, it did so with a profit margin of 18.7% and now looks well positioned for future growth.

2013's top income stock?
Despite the attractive incomes offered by Tesco and Morrisons, the U.K. utility sector remains one of the best places to find reliable, high-yielding income stocks.

The Motley Fool's top analysts have looked closely at all of the listed U.K. utility companies and identified one FTSE 100 utility share that offers a 5.2% dividend yield and that they believe may be significantly undervalued.

They are so confident in this share that they've named their report "The Motley Fool's Top Income Stock for 2013." This exclusive new report is completely free, but will only be available for a limited time -- so click here to download your copy now.

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Related Tickers

5/27/2016 12:10 PM
MRW $196.37 Down -0.43 +0.00%
Morrisons CAPS Rating: No stars
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Tesco CAPS Rating: ****
TSCO $168.26 Down -0.34 +0.00%
Tesco CAPS Rating: No stars