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01/05/2023 1
I will teach you how to invest in the grocery sector
01/05/2023 2
Most investors would look at revenue and profits to determine the fundamentals of a grocery company (or any other company for that matter). Some would identify ‘short-term’ trends, such as Sales growth, like-for-like sales or transaction value per basket. Others will look at the share price of businesses and determine when to buy the company’s stock (see below).
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Confused? Or, is there a pattern telling us when to buy?
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Pattern or no pattern in this presentation, you will learn:1. The best indicator to track a grocer’s share price performance.
2. The best combination of two indicators coming together that will tell you to sell the shares early, and, when to buy them.
3. Then there are things beyond our control. No metrics, charts, and sometimes fundamentals will affect the grocer’s market value adversely, or favourably.
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Which metric is best predicting the share performance of a supermarket ‘grocer’ share price? The market share of the grocery sector, especially their most established market.
You may have figured out in slide 3, I am using Tesco, Morrison and Sainsbury.
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The most effective indicator
Morrison’s MC Vs. Market share
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The most effective indicator
Tesco’s MC Vs. Market share
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The most effective indicator
Sainsbury’s MC Vs. Market Share
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The most effective indicator (Explained)You may have
noticed: A lagging effect on W Morrison’s chart between 2002-07 that is because it bought Safeway (another grocery company in the UK) back in 2003/04. The immediate increase in market share from 5.7% to 14.8% represented an opportunity to buy W Morrison’s shares. Here is why:It’s market value were behind the curve and this big divergence between MC Vs. MS needed to be closed. So in 2003, you could have bought Morrison for under £3bn or £1.25/share and in four years, the shares would exceed £3/share or £8.1bn.
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On the other hand, if the market value exceeded what was permitted, then the company is overvalued, purely based on the market share it holds.
More recently, Tesco and W Morrison’s saw its grocery market share decline, at the same time its share price depreciated greatly.
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We had the most reliable indicator. Now let’s talk about the second most reliable.
The ‘inflation-adjusted’ sales is grocery sales being discounted by UK inflation.
Using UK inflation data from the National Audit Office, I adjust the grocery’s sales by multiply the loss of purchasing power of money from the base year. For Tesco and Sainsbury, that is 1993, and for W Morrison it was in 1998. See for yourself:
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W Morrison’s chart
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Tesco’s chart
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Sainsbury’s chart
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Market Capitalisation Vs. ‘Inflation-adjusted’ Sales (Explained)If sales were not inflation-adjusted and we took Tesco, Sainsbury and W Morrison ‘SALES FIGURES’ at face value, then all the graphs would show sales in an upward trend Vs. a declining market capitalisation. With ‘inflation-adjusted’ sales, we get: 1. A strong pattern signal.
2. An early warning signal.
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In the Sainsbury’s chart, the correlation is not so obvious because sales in ‘real terms’ have been declining since 2000, but its market valuation has been trading sideways.
That is due to Sainsbury’s grocery market share in the sector being stable (see slide 8), and an increase in operating profits year after year since 2005 acted as support from further devaluation in its value.
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What happens when a grocer took on debt?
We can go on and on about the good and bad things that are debt. But one thing is clear, debt can be backed by tangible assets (land and property). It gives the impression when a company incurs debt; it would just sell the tangible assets to pay it off. The grocery sector, tangible assets are in abundance, even if you deliver grocery online (think warehouse!). However, one needs to look at its profitability and its rivals to gauge whether these ‘tangible assets’ can be sold at face value or a discount.
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Tesco’s market cap. Vs. Gross debt
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W Morrison’s Market Cap. Vs. Gross Debt
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Sainsbury’s Market Cap. Vs. Gross Debt
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The charts above are inconclusive, as investors have different views on a business loading up debts on its balance sheet.
But, despite, the inconclusiveness, there are three outcomes:
1. Leveraging up is good;2. Leveraging up is inconclusive;3. Leveraging up is bad. Each and every company responses differently when leveraging up. That is good in itself because we should know beforehand if leveraging up would be adverse, or favourable to the business.
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EARLY WARNING CHART + INDICATOR
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Earlier I’ve alluded that the Market Cap. Vs. ‘Inflation-adjusted’ Sales chart acted as an early indication to sell a company’s stock. And it’s a pretty effective indicator, as it gives the investor some years to sell their shares before a big decline ensue.
But there is one more early indicator with 4 combination graphs telling investors to get out:
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Morrison’s chart with combination of 4 different graphs
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Tesco’s chart
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Sainsbury’s chart
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By combining the Market Capitalisation Vs. Total Liabilities Vs. Tangible Assets Vs. Cash it tells the story of a company’s business operations and the funding requirement to achieve a higher return.
Interpreting the concept as follows: 1. Cash and tangible assets rise in proportion of liabilities causing financial leverage to remain stable, as the company grows its cash profits; - Likelihood of the share price rising.
2. When cash and assets fall, but liabilities increases, which will increase financial leverage meaning higher interest payments and the likelihood of dividends cut; - Likelihood of share price falling, or trading sideways (like Sainsbury’s).
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Lagging chart indicators – not so useful, but validation of why and when you are right in your assessment
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Lagging indicator number 1: Market cap. Vs. Dividends + Cash. W Morrison’s chart
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Tesco’s chart
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Sainsbury’s chart
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From both Tesco and W Morrison’s charts, the indicator is lagging when the company’s market value fell before the other metric started to fall (in this case, dividends and cash).
A business reason it’s a lagging indicator is dividends tend to be the last thing management wants to cut back on because of its adversity to the company’s share price.
Management would rather cut back expenditure, sell assets, or even borrow money to pay the dividends to stop shareholders from selling its shares. That would only work if the sector only suffers a temporary decline and recover quickly. However, long-term deterioration would leave management with no choice, but to cut the dividend.
The reasons
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Lagging indicator number 2: Market cap. Vs. Net Asset per shareSainsbury’s chart
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W Morrison’s chart
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Tesco’s chart
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It shouldn’t come as a surprise that the NAV is a lagging indicator because any company’s management would want to maintain, if not increase the value of its assets to ensure the net worth of the business, even when profits are down. As the stock market measures the future, then it is no surprise when shareholders and analysts start selling the company’s shares, as sentiment and business weaken with the lower operational performances being the likely outcome!
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Lagging indicator number 3: Nominal (current) sales Vs. Share price Sainsbury’s chart
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Tesco’s chart
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W Morrison’s chart
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Measuring a company’s sales against its share price wouldn’t help your prospects in making a fortune.
Sales would be a lagging indicator if the company’s management deemed sales as being an important metric to their end of year bonus! And cutting prices to boost sales would only hurt the company’s net margins and cash flow. Therefore, the share price is unlikely to response positively.
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Cycle-investing
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1. As long as earnings are positive, then a low earnings yield will mean share price is expensive, and a high earnings yield means share price is inexpensive. 2. If earnings yield is negative, the cycle of low and high earnings yield is broken. In fact, a negative earnings yield is accompanied by a falling share price.
Can you time your investment in the grocery sector? Yes, you can, only if normal business cycle resumes. The Share price Vs. Earnings yield chart can provide this answer, because:
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Sainsbury’s chart
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W Morrison’s chart
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Tesco’s chart
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As you may have noticed when earnings yield is negative in all three charts, the share price turns downwards, this is because the grocery sector has a thin profit margin. A more established supermarket has all kinds of obligations like pension contributions, operating leases, capex, dividends and so forth. So a loss-making year would be digging into the company’s piggy bank or asking for financial institutions for more money. TIP: Try using operating profit or EBITDA as a substitute for net profit, if earnings become negative. As seen in the Morrison’s chart, the metric is not fool proof to work 100%, and depends on individual companies.
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Why has the traditional supermarkets been doing poorly, as of late? Because of these ‘new kids on the block’:
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And how well did these companies perform? See below:
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These ‘Bad Boys’ has increased its UK grocery market share by more than 10% in 16 years.
And if their businesses are performing great, who is suffering?
Its rivals, they’re your local corner shops, past discounters like Kwiksave, and the big ‘four’ of TSCO, MRW, SBRY and Wal-Mart very own Asda.
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Below showed the market share of TSCO, SBRY and MRW in different periods:
They didn’t do too bad, and still their share price took a smacking!!
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Disclaimer – Events making financial metrics measures uselessExternal events will derail a company’s share price chart pattern, or your analysis of the business because it is ‘unforeseen’. So, your ‘buy’ recommendation becomes redundant when it is being investigated for ‘misreporting’ their accounting numbers!
Or, you put a ‘sell’ note because the company’s future prospects don’t look too bright, and an outsider appears to buy the business in the name of ‘synergy’. The grocery market is no different, here are some of the events that came about for Tesco, W Morrison and Sainsbury:
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1. Sainsbury has a bid from Qatar Holdings at around 600 pence/share, but it was firmly rejected.
2. W Morrison acquired Safeway in 2003-04 leading to a massive jump in its market share in the grocery sector.
3. And Tesco went around the world to set-up shop, but quickly found out its business model do play well with the locals.
Examples are a quick exit from the U.S. and Japan, as well as mounting losses in its Chinese operations.
However, earlier in the year, an accounting scandal came up when it misreported its financial numbers.
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Finally, I hope you enjoy my slides.
If you like what you see and read, please check out my website @ investeconomically.com , or follow me on twitter @Wh_biz32.Thank you for reading.