Tesco's dreary trading statement (UK like-for-like-sales down 1.5%) shouldn't come as a huge surprise.
No one should expect sales to be roaring away at the moment. Its business model in the UK needs fixing at a time when its customers don't have much spare cash.
In fact, what's surprising is that anyone thinks that Tesco can recover. Why should it?
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The same goes for Sainsbury's and Morrisons are these companies really going to grow? Are the billions of pounds that they intend to spend on existing stores and on opening new ones over the next few years really going to give their shareholders a decent bang for their buck?
For the last five years an investment in a UK food retailer has hardly been stellar. Yes, profits and dividends have grown, but share prices have gone nowhere. In fact, Sainsbury's shares have nearly halved and Tesco's are down by a third, while Morrisons' have basically marked time.
| Tesco | 446p | 300p | -32.70% | 8.7 | 5.00% | 2.32 |
| Sainsbury's | 559p | 289p | -48.30% | 9.9 | 5.70% | 1.77 |
| Morrisons | 297p | 280p | -5.70% | 9.9 | 4.30% | 2.33 |
Why such an awful performance? Obviously, the weak economy and an over-borrowed UK consumer are big parts of the problem.
But there is another reason overinvestment.
Supermarkets need to work out what to do with all that space
The supermarket sector is a stark example of the dangers of cheap money and the short-termism fostered by managements focused on earnings per share (EPS).
Put simply, with money in cheap and plentiful supply, building more supermarkets even with only modest returns on investment meant that as a manager, increasing EPS and therefore your bonus wasn't that difficult in the past.
I've recently written about how I think the returns on capital (ROCE) of the big supermarkets are nothing special. But the amount of money they have invested in recent years is now becoming a big problem for them.
Most urban areas are saturated with supermarkets. We don't need any more. Add in the fact that shoppers are not maxing out their credit cards any longer and you have to wonder: how are all these stores going to make acceptable profits, never mind grow them?
The three quoted supermarket operators seem to be stuck between a rock and a hard place. They neither offer really cheap prices like Aldi or Lidl, nor the perceived quality of a Waitrose or Marks & Spencer.
They can talk about growing online sales and convenience stores, but all that's really happening is that money a customer would have spent in one of their supermarkets is being spent elsewhere. This is mainly a strategy to defend existing sales rather than grow them.
This is particularly pertinent to Tesco, with all those big hypermarkets that it built to sell non-food items. How will these big stores pay their way?
Time for companies to change strategy
All of this said, while I'm bearish on the outlook for their businesses, the share price weakness of the UK supermarkets in recent weeks means that they are entering interesting territory.
All three are trading on single-digit price/earnings ratios, while offering decent dividend yields that are reasonably covered. Indeed, I'm almost tempted to say "Buy", but I'd hold back for one main reason.
The stock market is telling us that throwing money at supermarket assets is not a smart thing to do. It's now down to supermarket managements to admit that the game is up. If they don't, they will carry on throwing good money after bad in pursuit of growth and returns that are simply not there.
The alternative is to stop building new stores, invest in customer service and focus on generating lots of surplus cash to pay bigger dividends. This is what a private equity buyer would do.
Throw in the fact that financing could be secured against freehold land and buildings and you have the basis for a takeover bid for Sainsbury's or Morrisons. The only uncertainty is the right price to pay for these assets. Tesco, due to its size, is probably bid proof.
There's lots of pessimism in UK food retailing at the moment, but for investors that is when opportunities arise. There's a price for most assets, and while the business fundamentals aren't brilliant, this sector is worth watching now.
Phil Oakley owns shares in Morrisons.
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