Supermarkets in the spotlight

Helal Miah, investment research analyst at The Share Centre, shares his view on the Food and Drug Retail sector ahead of Tesco and Sainsbury's reporting on Tuesday.
 
"This small sector is dominated by a few blue chips, so competition tends to be fierce as the big players seek to diversify their produce and services. Its defensive nature offers investors the potential for growth and income and some representation of this sector should be a core component in an investor's portfolio, particularly for those seeking a balanced return.
 
"The supermarkets invest a lot of resources on marketing the right message and product range during frugal times to maintain customer loyalty and win market share, as budget retailers continue to pressure. In Morrison's interim report earlier this month the retailer continued with its cautionary note saying that despite the economy showing signs of improvement consumers are not feeling the difference in their pockets.
 
"Analysis from The Share Centre's Profit Watch UK report (data reported up to the end of June 2013) showed weak consumer spending has constrained the ability of retailers to grow their sales. Food and Drug retailers have been reporting sluggish growth of just 1.7% in revenues across the FTSE 350 compared to a year ago. While food retailers managed to grow their top line, they did so at the expense of margins which have been under intense pressure in the last year, with net profits falling by 36.7% to £2.7bn. Food and Drug retailers play a vital role in the FTSE 350, accounting for 5.4% of its net profits on a rolling annual basis."
 
Miah highlights what investors can expect from Sainsbury's and Tesco's updates on Tuesday.
 
Sainsbury (trading statement) - HOLD
 
"Sainsbury's posted a good set of full year results and gained market share so investors will be hoping to hear more of the same from this trading update. As competition in the sector increases any news on the strategies that management may consider will be of interest, especially as Tesco begins to focus on the UK market once more.
 
"We continue to recommend a solid ‘hold' for now. For income investors already holding the stock the dividend is currently well covered. The business has a strong management track record and market share growth has been impressive. However, market conditions are challenging and competition remains tough."
 
Tesco (Q2 results) - HOLD
 
"Profits in the sector have been under pressure as discount retailers steal a march in a weak economic environment. Investors will be keen to hear about gains or losses of market share and the payoff from the latest round of discount wars that supermarkets have found themselves involved in. Other updates that will be welcome are the status of its US exit strategy, UK store openings and the progress of its banking and internet shopping business.
 
"We recommend Tesco as a ‘hold' for investors. Whilst we remain confident in the management and their ability to turn the UK operations around, we believe the implementation of their new strategy and the regain of market share will take some time. Given that the global economic slowdown is likely to remain a challenge, as well as fierce price competition and promotions, we continue to believe that the shares could be dull for a period, leaving investors to focus on the yield."

For more information, visit share.com.