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Should I Buy Tesco or Wm. Morrison Supermarkets?

Roland Head
April 25, 2013

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.