Don’t let Tesco put you off investing in retail stocks

Tesco had yet another terrible day yesterday. Its latest results were rotten and the share price fell by nearly 7%.

Even after yesterday’s fall, here at MoneyWeek we still think now isn’t the right time to invest.

But that doesn’t mean you should avoid the whole retail sector. There are some attractive stocks out there and the economic backdrop is reasonably positive.

So if you want to find out about two of my favourite retail stocks, read on.

Why you shouldn’t buy Tesco shares

But first, I should explain quickly why we think you shouldn’t buy Tesco shares just yet. The company’s biggest problem is that it simply isn’t generating enough cash. And if it tries to boost cash flow by squeezing its suppliers, the suppliers can say something like this: “your market share is falling, you’re not so powerful any more. If you don’t like our terms, tough.” Or something like that, anyway.

Granted, there’s a chance that a mega-bid from private equity might emerge some time soon, but there’s only a chance of that happening, and I suspect that the chance is lower than many people realise. So when I weigh up the risk/reward ratio, there’s no way I’m going to buy at last night’s share price of 171p.

And if you’d like to read a more detailed analysis of Tesco’s problems, read Phil Oakley’s excellent article – Tesco shares could tank below a pound.

There are much better retail stocks than Tesco

So where are the better retail stocks than Tesco? Well I don’t think that Sainsbury’s or Morrisons are much more attractive. And like Tesco, they’re also struggling to cope with structural issues such as increased online shopping and the rise of Aldi and Lidl.

But I am getting increasingly interested in Marks & Spencer (LSE: MKS). Granted, M&S has had plenty of problems over the last 15 years, and even now its clothing offer could be improved.

But the big plus point for M&S these days is that more than 50% of its sales are in food. And a lot of those food sales are made at the fast-growing Simply Food chain. Simply Food fits very well with the current trend in food retail – the move away from the big weekly shop on a Saturday to smaller, more frequent shops at stores that are nearer to home or work. As a result, I think that M&S can continue to grow its market share in food.

And it’s not just the standalone Simply Food stores that chime with current trends. Many of the larger M&S stores that offer both clothing and food are on traditional high streets rather than big out-of-town retail parks. So for many people, it’s easier to drop into a large(ish) M&S rather than a really large Tesco Extra near a big road junction.

The Simply Food chain also means that M&S has plenty of locations where online shoppers can pick up their ‘click and collect’ purchases. All of these pick-up points are an important asset, which can only become more valuable in future.

I also think that M&S is beginning to make real progress with its website, and that may enable it to take a bit of market share from Next (LSE: NXT) in the online clothing space.

That said, I do realise that M&S still needs to do more work on its womenswear offer. Back in the 20th century, womenswear was the chain’s bread and butter, but the company’s continuing struggle in this area has been the main reason why M&S has struggled so much since the millennium.

However, I think that continuing issues with womenswear are fully reflected in the share price. At 419p, M&S is trading on a relatively low price/earnings ratio of 12, and is on a 4.4% dividend yield. I don’t own shares in M&S, but the share price is now cheap enough to tempt me.

M&S’s big rival in clothing, Next, is more expensive. It trades on a price/earnings ratio of 15. However, if you’re prepared to pay that higher price, you get a company with a fantastic record and a management team who keep on getting it right, quarter after quarter. I own shares in Next, and I have absolutely no intention of selling them.

Don’t worry too much about September’s poor sales figures

There’s one other issue that I want to look at today. You might have seen that September saw a decline in retail sales volumes – in other words, a decline in the actual number of items sold.

Now, that might worry you, but I don’t think it should as I suspect that October and November will be much better. That’s because the unusually good weather in September meant that many folk delayed their purchases of new autumn/winter clothing, but they’ll be making those purchases now.

The recent improvement in the UK economy should also boost retail stocks. George Osborne will do everything he can to ensure that the economy continues to motor until the election in May, so that’s another reason to make a modest investment in Marks & Spencer or Next.

Don’t let Tesco’s travails put you off retail stocks!


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