Is now a good time to pick up supermarket stocks on the cheap?

Wm Morrison (LSE: MRW) issued a terrible profit warning yesterday.

Shares in the supermarket chain have slumped 11% since the announcement.

The warning also triggered share price falls for Sainsbury (LSE: SBRY), down 5.5%, and Tesco (LSE: TSCO), down 3.5%.

So is now a good time to stick some supermarket share bargains in your portfolio?

Morrisons has had a rotten year

Well, let’s start with Morrisons.

Yesterday’s warning wasn’t a total surprise.

After all, it followed an earlier warning in January and you often find that struggling companies issue a run of disappointing updates. (The old market saying is that profit warnings come in threes.)

But the scale of the warning was shocking, and it was accompanied by rotten full-year results as well.  In fact, Morrisons actually made a £176m loss last year.

Granted, once you strip out various exceptional costs, you get an ‘adjusted’ pre-tax profit figure that’s firmly in the black. But even adjusted profits are down 13% at £785m.

Even worse, Morissons now expects pre-tax profits to fall around 55% this year. That’s way more than analysts were expecting.

Morrisons’ boss, Dalton Phillips, is also pushing through some big writedowns on the balance sheet. He hopes to sell the Kiddicare baby equipment subsidiary, and he’s already written down the value of that business.

And he’s writing down the value of the property estate too. It’s these writedowns that have pushed the ‘official’ profit figure into the red.

But the boss is making some right moves

In fairness, Phillips seems to making broadly the right moves.

He recognises that the company’s late moves into online and convenience stores was a mistake; he’s going to launch a loyalty card; and he’s cutting prices. The profit margin has already fallen from 5.3% to 4.9%.

However, I’m not tempted to buy any shares. Granted, if you look at last year’s profits, Morrison is on a price/earnings (p/e) ratio of eight.  But for  this year, the p/e will be more like 18.  That’s well ahead of Sainsbury’s and Tesco, which are both on p/e ratios of ten.

I also fear that Morrison will be pressed into making further price cuts later this year and that could lead to another profit warning.

But the most important problem is that the whole supermarket industry is going through huge structural change at the moment. There’s the rise of Aldi and Lidl, and the huge growth in online retail.

Given that backdrop, the shares don’t look cheap to me. I’m not buying.

So what about Tesco?

I’ve been pretty bearish about Tesco since I joined MoneyWeek, so I felt vindicated when I saw that Warren Buffett has sold some of his shares in the company.

However, my colleague,  Bengt Saelensminde, was more positive about Tesco last week. Bengt thinks the company’s turnaround strategy is beginning to bear fruit, and he also reckons that Tesco could be a dotcom giant in the future.

I can see where Bengt is coming from, and there’s a decent chance he will be proved right. But I’m not going to buy myself because I worry that, like Morrison, Tesco will have to make further price cuts in the future, and that will bring down margins and profits.

Sainsbury’s is in trouble too

It’s a similar story with Sainsbury’s.

Its margin is already on the low side at 3.7%, and you can’t rule out further falls in profits to come.

Remember Sainsbury’s doesn’t just face competition at the bottom end of the market from Aldi and Lidl. It also faces pressure from Waitrose, which has just achieved 5% market share for the first time.

So, overall, I’m pretty gloomy on the supermarkets. I reckon share prices could have further to fall. And if they don’t fall, they’ll probably stay static and not make any significant gains.

There will come a time when it makes sense to buy in, but I don’t think we’re there just yet.


Merryn

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