Investing.com -- RBC Capital Markets has initiated coverage on two of the UK’s leading grocery chains, Tesco Plc (LON:TSCO) and J Sainsbury Plc (LON:SBRY), flagging their strong market positions but diverging growth and valuation prospects.
While Tesco receives a "sector perform" rating, reflecting limited upside potential from current levels, Sainsbury's has been initiated at "outperform" as analysts see greater room for growth and valuation gains.
Tesco, the UK's largest grocer with a 28% market share, has performed strongly in recent years, including a 26% share price increase over the past year.
RBC analysts note that Tesco’s valuation, currently trading at around 12 times estimated 2025 earnings, aligns with historical averages.
The company has benefited from market share gains, mostly at the expense of competitors like Asda and Morrisons, but further growth could prove challenging as these rivals stabilize under new leadership.
Tesco also faces some headwinds in its Booker wholesale division and Central European operations, where recovery is expected to be slow.
However, the company’s focus on cost efficiency and new revenue streams, such as retail media and its online marketplace, could drive long-term margin expansion.
RBC forecasts Tesco’s operating profit margins could rise from the current 4.2% to 4.5% over time.
Additionally, with a strong free cash flow yield of around 7%, Tesco is well-positioned to continue returning cash to shareholders through buybacks.
RBC analysts are more optimistic about Sainsbury's, the UK’s second-largest grocer with a 15% market share.
After years of decline, Sainsbury's has reversed its fortunes, gaining 0.6 percentage points of market share over the past two years. This improvement is attributed to the company’s sharper focus on its Food business, including pricing, product range, and availability.
Its premium “Taste the Difference” line has been a standout performer, growing at twice the market rate, and Sainsbury's plans to expand its full Food range to more stores.
Sainsbury's has also maintained a strong track record of cost control, achieving over £1 billion in savings in the past three years.
Analysts expect similar savings in the coming years, driven by efficiencies in space, supply chain, and product range.
Meanwhile, alternative revenue streams, particularly through retail media leveraging its Nectar loyalty program, present high-margin opportunities. RBC forecasts Sainsbury's margins to improve by 30 basis points to 3.3% by FY27.
With a strong balance sheet and strong cash generation, Sainsbury's is expected to remain at the lower end of its debt target range, providing room for additional cash returns. Return on capital employed is projected to reach 12% by 2026, reflecting a solid financial foundation.
Despite these strengths, Sainsbury's trades at only 10 times its estimated 2025 earnings, below its historical average and at a discount to Tesco.
RBC believes this valuation does not fully reflect Sainsbury's potential for continued market share and margin improvements, supporting its "outperform" rating and a price target of 300p.