Berenberg bumps up Tesco, Morrisons ratings

Berenberg upped its stance on Tesco and Morrisons on Friday as it took a look at the UK food retail sector.

The bank upgraded Tesco to 'buy' from 'hold' and lifted the price target to 255p from 190p. It said conditions in the sector are improving, with inflation headwinds easing and competitive pressures subsiding.

"Tesco’s recent store like-for-like outperformance, underpinned by improvements in customer satisfaction and in-store execution, together with further revenue self-help opportunities in mid-tier own label make us more optimistic on mid-term margins in UK retail segment."

In addition, it said that following the collapse of wholesaler Palmer & Harvey, there is further upside to deal synergy guidance and Berenberg expects strong earnings per share, free cash flow and leverage accretion post the integration.

"We view Tesco as the most attractive investment in food retail, providing 30% EPS compound annual growth rate in 2017-2019 while trading on 13.5x price-to-earnings and 8.0% free cash flow yield in CY 2019."

The bank recommended buying the stock ahead of the FY 2017 results on 11 April 2018, which it sees as a positive catalyst.

Also on Friday, Berenberg bumped Morrisons up to 'hold' from 'sell' and nudged the price target up to 210p from 200p.

It said that while Morrisons remains too expensive for an income stock, the shares have come down 13% since the peak.

"We believe the key catalysts for underperformance have already materialised, with wholesale dilution, free cash flow generation and margin growth expectations now much more realistic and relative margin performance potentially improving as inflation tapers down. "

Berenberg noted the stock is now trading at 14.5x three-year forward price-to-earnings on consensus and said a strong balance sheet and capital returns potential should continue supporting the sentiment and valuation at these levels.

At 1050 BST, Tesco shares were up 1% to 204.90p and Morrisons was down 0.4% to 223.90p.