Broker tips: Tesco, Sainsbury's, Whitbread, Pets at Home

Exane BNP Paribas downgraded Tesco and Sainsbury on Friday as it took a look at food retail, leaving it with no buys in the UK.

The bank cut Tesco to ‘underperform’ from ‘neutral’ and pushed the target price down to 175p from 200p pointing to a high risk of de-rating given a building risk that inflation isn’t fully passed through to the shopper, a tougher industry volume outlook and nothing in its recent consumer survey to prove volume growth is a given.

“Though Tesco has made good progress so far, we would remind it is in essence a hypermarket player twice the size of its nearest competitor in the UK.”

Exane downgraded Sainsbury to ‘neutral’ from ‘outperform’, keeping the price target at 255p.

“With our target price now a little below the current share price and a building risk cost inflation isn’t passed through to the shopper smoothly, we cut our rating,” it said.

Exane noted Sainsbury is still the least-loved UK food retailer. It’s at a marked discount to Tesco and Morrisons, amid ongoing scepticism that the group can hold, let alone grow margins.

“We think pockets of the market are still too bearish but the valuation now better captures the story.”

On food retailers more generally, Exane said it reckons 2017 will be tougher for volumes, with higher food inflation likely to take a bite, along with ongoing discounter/online headwinds.

In addition, it said wage inflation will persist and having already adjusted shift patterns and premiums, there are fewer options to offset the pressure.

Whitbread’s shares were given a boost on Friday after Barclays lifted its rating on the stock to ‘equal weight’ from ‘underweight’ and raised the target price to 4,150p from 3,340p.

Barclays said it expects the owner of Costa coffee shops and Premier Inn hotels to report a “good” third quarter and an “excellent” fourth quarter trading statement on 26 January on the back of strong data in London and the UK.

The bank noted that updates elsewhere in the sector, including Mitchells & Butler, show that restaurants have performed well. Whitbread owns restaurants Beefeater Grill and Table Table.

Barclays also expects coffee shops to have benefitted, particularly given the easy comparatives at Costa.

“While Whitbread has had a good run as investors have seen this data, we still see potential for the update to be a positive catalyst,” Barclays said.

“We upgrade our earnings per share estimate by 2.7% in fiscal year 2016/17 and 5.6% in 2017/18, reflecting stronger third quarter and fourth quarter trends and our expectation for a good first quarter 2017 (strong services purchasing managers’ index) but weaker second to fourth quarter this year.”

However, the outlook on the revenue per available room (RevPAR) for the group’s hotel business looks “fraught with uncertainty” amid Brexit, Barclays said.

Strong UK macro growth with a continued weak pound would support RevPAR, putting it at the higher range of Barclays’ guidance of between 2% and 5% over the next year.

Barclays said the weaker pound and terrorist attacks elsewhere in Europe has boosted tourism in the UK. The drop in sterling has also led to more ‘staycations’ with British residents opting for domestic holidays.

Pets at Home's shares fell on Friday after HSBC downgraded the stock to ‘hold’ from ‘buy’ and lowered the target price to 230p from 290p after the company reported its third quarter trading update.

The pet supplier on Thursday said group revenue was up 4.4% to £203.7m in the 12 weeks to 50 January, with like-for-like revenue growth of 0.1%, reflecting continued strong growth in veterinary services, offset by more subdued trading across the Merchandise business. The company said the profit outlook for the year remains in line with expectations.

HSBC said the third quarter sales growth was below its expectations of £207m, led by a 0.5% like-for-like sales decline in the Merchandise business.

“Structural market growth and maturity should have been strong supporters of positive like-for-like growth, so this is a disappointing performance,” said HSBC.

“Lower footfall was the main cause, with customer feedback suggesting Pets at Home (PAH) needs to improve its value credentials.”

However, management is responding to customer feedback by investing in price with the initial focus on its own label food.

HSBC believes the investment in its own label, which is higher margin than branded products, should support margins.

“Pets at Home’s shift of strategy is likely to see it become more sales growth led and less gross margin led – an encouraging move, in our view. It suggests Pets at Home will increasingly share the benefits of its dominant advanced nutrition position with consumers.”

The bank added that the firm’s competitive advantages should mean it is well placed in the long term if it pursues the right strategy.

However, changes may take some time to positively impact customer perceptions and behaviour given an average purchase frequency of about seven times a year.

“It may be a few quarters before we see the benefits of the shift in strategy,” HSBC said.

The bank cut its forecasts for earnings per share by 2-5% for fiscal years 2018 and 2019, reflecting a “more cautious outlook”. A 3.5% dividend yield with potential for special returns, on a strong cash generation, should offer support in the meantime, HSBC said.