Morgan Stanley (NYSE:MS) has made Tesco PLC its top pick in the European retail sector in a wide-ranging note that includes an upgrade for J Sainsbury PLC (LSE:SBRY) but downgrades for H&M, Primark-owner Associated British Foods PLC and Kingfisher PLC (LSE:KGF).
The investment bank said its thesis for the year ahead is simple.
As price inflation moderates across geographies, top-line growth will become increasingly reliant on volumes.
“We expect retailers who are in the sweet spot to be rewarded by the market, as volume-led top-line growth should command a higher multiple and as volumes improve, margins stand to benefit from operating leverage."
The bank said the market is overly fearful of deflation and is missing the bounce-back in volumes.
Morgan Stanley (NYSE:MS) expects volumes/mix to turn positive from the second quarter of 2024, driving 2025 annual growth of 2.5%.
On the inflation front, the investment bank expects 1%-4% for the year ahead.
Tesco, rated 'overweight,' is its top pick. “We see 6% EPS upside to Street,” the bank said.
It also expects the cash payout at the UK's largest food retailer will be increased at the annual results (via an extra buyback or dividend) and has raised EPS estimates.
The bank upgraded Sainsbury to 'equal weight' from 'underweight,' predicting an improving margin outlook in grocery, plus the launch of a buyback at its CMD.
It raised EPS estimates by 5% and 11% for the next two years.
But Primark-owner AB Foods was cut to 'equal weight' from 'overweight' with the broker believing the "margin recapture narrative has played out while there are risks to volume growth".
Kingfisher was downgraded to 'underweight' from 'equal weight' with Morgan Stanley expecting trends in DIY across UK/France/Poland to remain challenging for the next 12 months.
It expects consensus forecasts to come down a further 4%.
B&M European Value Retail SA (LSE:BME) remains at 'equal weight' with Marks and Spencer Group PLC (LSE:MKS) reiterated at 'overweight'.