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Tesco and Sainsbury's shares: where next for supermarkets?

The coronavirus pandemic has caused the FTSE 100 to plummet, but supermarkets like Tesco and Sainsbury's have bucked the trend. Can this realistically continue?

Tesco Source: Bloomberg

In the period between the start of March and the beginning of trading following the Easter weekend, the FTSE 100 shed around 12% of its value. Tesco posted a rise of 2.3% and Sainsbury's share price weakened by less than 1% in the same timespan.

At a time when several companies have suspended normal business operations, supermarkets are benefiting from trading that more closely resembles 'business as usual'.

These are still unusual times for supermarkets, given that the rush to stockpile goods swelled Tesco sales by around 30% as lockdown measures were introduced in the UK. The UK grocery industry generated sales worth £10.82 billion in a four-week period ending 22 March, a 20% increase on the same period in the previous year.

Sainsbury's was the biggest beneficiary in the March rush, with figures from Kantar indicating that the supermarket enjoyed a boost in trade by 22.4%. Kantar analysts attributed that outperformance of the national supermarket average to Sainsbury's strong presence in London, with stockpiling particularly intensive in the UK capital in March.

While these numbers ostensibly appear welcome for supermarkets like Tesco and Sainsbury's, there are concerns over whether these companies will actually benefit from increased consumer demand.

Are UK supermarkets a potential haven amid pandemic?

Business rates relief reduces pressure on supermarkets

The government's decision to provide a comprehensive holiday on business rates has been well received by supermarkets, although that reception has been frostier in some quarters.

A 18 March note on business rates from Sainsbury's indicated how the supermarket 'welcome[s] the support' from the government. Sainsbury's paid over £500 million in business rates in the financial year ending March 2019.

In that same year, Sainsbury's posted pre-tax profits of £239 million. Sainsbury's share price rose by around 13% following the news that the business rates holiday would save the supermarket more than double its annual profits.

Tesco has also capitalised on business rates relief from the government, saving around £585 million. The supermarket giant drew ire from some commentators by taking this rates holiday at the same time as distributing £900 million to shareholders in dividends.

That ire was exacerbated by the fact that Tesco generated pre-tax profits of £1.3 billion in the 12-month period beginning February 2019, thereby appearing to have the capital required to ride out the economic turmoil of the pandemic.

Tesco chief executive officer (CEO) Dave Lewis stressed that the government assistance is required to handle the conditions of the pandemic while reinforcing a need for dividend payments to support 220,000 small investors. Tesco's share price unsurprisingly soared following this move to reward shareholders. On 9 April, the day after the dividend news broke, Tesco shares rose by 4% to close at 232p.

Supermarkets face challenge to convert short-term sales success into long-term prosperity; analysts remain unconvinced

In a press release assessing the impact of COVID-19 on Tesco's financial health, the company indicated that a return to normal consumer behaviour by August could see much of that additional expenditure offset by food volume increases, business rates relief, and 'prudent operations management'.

Despite Tesco's commitment to its investors and optimistic August forecast, Shore Capital analysts downgraded the supermarket stock to 'hold' amid concerns that Tesco may pay as much as £925 million to finance recruitment and distribution during the pandemic.

At the same time, Shore Capital placed its 'buy' rating on Sainsbury's stock under review. This caution is based on fears that new consumer patterns during the pandemic will place excessive strain on supermarkets' operations.

While the March increase in sales and strong share price performance provide eye-catching numbers, both will be undermined in the long term if supermarkets have to spend millions more to meet consumer demand.

With the UK government not expected to relax lockdown measures in the coming weeks, supermarkets should continue to outperform the wider market in the short term. April shopping figures will be instructive in revealing whether that March boom was purely driven by panic or representative of new consumer patterns during the pandemic.

How to take a position on UK supermarkets

What’s your view on UK supermarket stocks? Will the global pandemic help or hinder their share prices? You can take a view on Tesco or Sainsbury’s shares – both rising and falling – with IG.

  1. Create an IG trading account or log in to your existing account
  2. Search for ‘Tesco’, or ‘Sainsbury’s’ in the search bar
  3. Choose your position size and click ‘buy’ to go long, or ‘sell’ to go short
  4. Confirm your trade

Remember you can also invest and own shares with IG. Commission on UK shares is £3 if you’ve traded three or more times in the previous month. It’s just £8 otherwise.

The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG Bank S.A. accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer.

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