Tesco to win on price cuts, Morgan Stanley says

Tesco will be the winner with price cuts set to be a major theme for grocers in 2021, Morgan Stanley said as it increased its price target for Tesco shares.

Morgan Stanley's analysts said Tesco had led price deflation in the UK with prices down 0.8% since June. Britain's biggest supermarket has the scale to take advantage of this by agreeing promotions and rebates with suppliers, they said.

This applies to physical stores, where Tesco has 27% of the market, and online where Tesco's share is 36%, analyst Maria-Laura Adurno said. She reiterated her 'overweight' rating for Tesco shares and increased her price target to 287p from 276p.

Investors are also overlooking cost cuts and market share gains available to Tesco at its Booker wholesale business, Adurno said. She estimated Tesco could save between £340m and £1.7bn on labour, cost of goods and general expenses.

"This could be reinvested in prices and contribute to overall revenue momentum," she wrote in a note to investors. "At the time of its 1H results, Tesco stated that Booker had gained market share and we believe that Booker can sustain this competitive advantage gained during the lockdown given its scale and variety of product sourcing."

Adurno also increased her price target for Sainsbury's shares to 214p from 205p and kept her 'equal weight' rating on the shares. Investors may be underestimating Sainsbury's ability to cut costs from its Argos business by streamlining operations, she said.

"This segment could see £150m/£500m in incremental Ebit [earnings before interest and tax] coming through from streamlining operations," she wrote. "We stay on the sidelines however as we see limited earnings momentum."

She kept an 'equal weight' rating on Morrisons but cut her target price by 20p to 189p because of limited earnings momentum and lack of scale in online and convenience stores.

Adurno said the market was overestimating the strength of discounters Aldi and Lidl, which have taken market share from the big grocers with cheaper prices.

"We acknowledge that discounters are likely to continue to gain market share at the expense of the traditional grocers," Adurno said. "However, given the value reinvestment by traditional grocers … we do not see a risk of discounters launching a price war in the UK, particularly as their sales growth rate is slowing."