Crunch time for the grocers

Food was the most resilient retail sector during the recession because, after all, people always need to eat. That enabled the grocers to enjoy years of continued growth, despite the tough economic climate. But the mounting pressure on consumers’ purse strings has led to the near-unthinkable happening – food volumes are falling at the greatest rate in a quarter of a century.

Food volumes slid by 4.2% in June, the Office for National Statistics (ONS) revealed, the steepest fall since records began in 1988.

With their finances under pressure as the costs of necessities such as energy and transport rise, consumers have little choice but to make savings on all of life’s essentials, including what they eat.

The problem is made worse for shoppers by the spiralling cost of food as a result of commodity price increases. The ONS reported that food prices rose by 5.8% year-on-year in June, the greatest increase for two years.

A survey from consumer group Which? earlier this month found 84% of people are worried about the rising cost of food, and some have changed products to cope. Some are buying value brands, others bigger value packs.

So where does that leave the grocers? Of the big four, only Morrisons gained market share according to the most recent Kantar industry figures, showing that they are all facing the same issues. And, at present, it is difficult to see where further growth will come from.

Grocers have been protected to a certain extent by food inflation but when that is stripped out, along with contributions from petrol and new stores, Shore Capital analyst Clive Black says that “the industry has been experiencing declining like-for-like volumes for a more sustained period than we sense anyone in the industry has witnessed before”.

He says: “2011 was always going to be a slog for the consumer with the impact of the VAT rise in January, plus several other stimuli that had previously supported the consumer came to an end. We don’t see any let up in the second half of the year.”

The difficult first half, apart from a boost in April from the royal wedding and bank holidays, led to Black downgrading the grocers. Sainsbury’s, he believes, is at most risk and he cut his current pre-tax profit forecast for 2011/12 by 7%, or £48m, to £669m. Tesco and Morrisons did not escape either – downgraded 1.4% and 2.5% respectively.

Waste not want not

Falling food volumes are being driven by two major factors, says Grant Thornton head of food and beverage Trefor Griffith. He says the rising cost of food alongside other pressures such as petrol prices is the dominant reason, but he also says the ethical issue of food waste is at play.

“Consumers simply having to tighten their purse strings is by far the biggest reason for volume declines, but shoppers are also now much more aware of food waste,” he says.

“Environmental issues have been getting more prominent in shoppers’ minds for several years but food waste has been accentuated this year, as throwing away less also means they save money.”

Griffith says that the trend can be seen in the fact that the two big growth streams for the supermarkets are online shopping and convenience stores.

“Online is growing but it is also adapting to the new environment,” he says. Griffith points to Ocado as an example, which has started offering shoppers products, such as sausages, in small numbers so that customers do not have to buy big packs. “Ocado has found that its average order size is decreasing, but the frequency of shop has increased,” he says.

Convenience stores have also become a key battleground for most grocers. While Tesco dominates by a country mile, Sainsbury’s is expanding fast and Morrisons has just opened its first convenience store, M-Local in Ilkley, West Yorkshire. Waitrose has also highlighted convenience stores as a central plank in its growth strategy.

Sainsbury’s chief executive Justin King said early this year that customers were putting one less item in their baskets and topping up their shopping at c-stores. This looks likely to be the norm for a while says Griffith.

Quality not quantity

So just how sticky is the situation for grocers? Oriel Securities analyst Jonathan Pritchard says “life is tough”. He explains: “They may benefit a bit from inflation but that is not enough to secure growth.”

Grocers may also benefit from offering quality, as many have pointed out that shoppers are not necessarily buying the cheapest products. They may buy less, but they may opt for more quality in their shopping baskets.

However, Black points to Sainsbury’s as the biggest possible loser, although the rest of the big four have also come under pressure. He says: “Sainsbury’s operating margin is lower than Tesco and Morrisons, so if sales growth across the industry slows, then Sainsbury’s will be much more geared into that slowdown.”

Another factor, he continues, is that while Sainsbury’s is opening a similar amount of square footage to Tesco, in percentage terms it is higher and “that new space will be finding life a little tougher as well as the existing stores”.

However, Black says grocers are “doing all they can in the difficult circumstances”. He points out that supermarkets are running promotions, paring back operating costs and conserving cash.

“Promotions are running at a high level but food retailers are using them sensibly for offers, rather than all trying to offer EDLP and leading to a price war,” he says.

However, Kantar Retail director of retail insights Bryan Roberts says the high level of promotions may end up causing the grocers some problems. “They are locked in a Mexican stand-off in terms of scaling back their promotional strategies,” he says.

“Customers have learnt only to buy on deal in many categories, such as shower gel or cheese, as they often have zero brand loyalty, so there is no reason to go back to buying at full price.”

Roberts says the level of promotions could result in the grocers struggling to be able to show the real value of a product to the shopper.

Black points to operating costs being trimmed as a positive. He says: “From visiting stores you can see there are slightly less people on the shopfloor. The stores are a little less tidy and the service may not be quite as good as it once was, but that is all part of managing cost base down.”

Operating costs, promotions, and cash being conserved are “the three things that have to be worked on when the top line is suffering”, says Black.

Opposites attract

Pritchard believes Sainsbury’s is being squeezed by Waitrose and Marks & Spencer. “Both Waitrose and Marks & Spencer are doing a lot right at the moment and that is hitting Sainsbury’s. While Sainsbury’s stores look fine, Waitrose and Marks & Spencer look much better, and that is showing in their figures.”

Kantar also highlighted the growth of Aldi and Lidl at one end of the food market and Waitrose at the other as a strengthening trend. In the figures for the 12 weeks ending July 10, Aldi and Lidl continued to post double-digit growth of 20.2% and 15.6% respectively. At the other end of the scale, Waitrose grew by 9% and increased its share from 4.1% a year ago to 4.3%.

Black believes this trend has occurred because, despite the tough climate, “we still have the haves and the have-nots”.

He says: “The have-nots are trying to squeeze out as much as they can from their budgets so they have little retail loyalty, are using promotions more, and shopping more frequently at local stores, which means Aldi and Lidl are well placed. The haves are those whose lives have continued as normal, who have no mortgage, perhaps a handsome pension, and continue to shop at Waitrose.”

With the growth in online and convenience shopping, some believe Tesco, Sainsbury’s and Asda are more susceptible to suffer as they have larger out-of-town stores.

“Shoppers don’t want to drive out of town to use unnecessary petrol, plus they’re not buying as much non-food as they did previously so they don’t need to go there for that,” says Black.

“By default this means that Morrisons may be more resilient in the short term as it doesn’t have the larger out-of-town superstores or a large non-food offer.”

However, Griffith says this does not spell the end of larger out-of-town stores. “Morrisons’ business may be most suited to the current environment but trends change quickly in retail and out-of-town may well come back,” he maintains.

Black believes online will not replace stores and that non-food will once again become a powerhouse for the grocers. “Some people have pointed to the music sector and believe that all sectors will go the same way and be predominantly online,” he says. “But CDs were replaced by a digital option and you can’t do that with a carrot or a pair of trousers, so there will always be a need for physical stores.”

Black also says that, while non-food has taken a hammering lately, he expects growth in non-food will start to stabilise and pick up in 2013/14, then “it will start to be a real growth engine for the grocers again”.

Morrisons, too, also wants to develop a credible non-food offer, so “it clearly sees the long-term potential”, he says.

The grocers, along with the rest of the retail sector, are finding life hard at present. But, as Griffith says, the grocers are “big and well diversified” so they are better placed to cope than many retail businesses.

It may be tougher for the supermarkets than it has been for years, but few would bet against the grocers in the long term.