Comment: A perfect storm has left the grocery market in the doldrums

The latest Kantar data reveals a British grocery market that remains firmly in the doldrums. Given favourable comparatives, a rising population and now on-going economic growth, this weakness underscores the challenges that the industry and the large supermarkets in particular face.

Consumer behaviour in the UK is changing with households still carefully managing their budgets. Whilst employment levels are high, living standards are growing at a very pedestrian rate and groceries have been a key lever in managing down household budgets.

An increasing number of folk are eating out more, where value can be strong in pubs and cafes, plus the affordable treat remains a robust feature of spending patterns.

Such a mix is arguably a ‘perfect storm’ for the Big Four retailers, which were arguably taking their customers for granted through much of the economic downturn by depending upon inflation for sales and over-protecting gross margins. Unfortunately the shoppers worked their trading strategies out and went elsewhere.

The Big Four ‘fight back’

Asda started the process of the Big Four ‘fight-back’ for customers in 2013 when it ‘smelt the coffee’ first of the prevailing consumer mood. Whilst promotions are a deep feature of the British grocery market, these were eased back by Asda whilst the fog of vouchers and other stunts was materially cut out.

Correspondingly, Asda started to see the benefit from a more simple and transparent value and has been the fastest growing of the Big Four players in 2014.

Tesco sustains particularly weak trade with sales said to be 4.0% lower year-on-year for the 12-week period. Such trade is against favourable comparatives and underscores the reasons behind ‘regime change’.

We expect Tesco to be more competitive on base pricing as part of a re-engineered offer to its customers under designate CEO Dave Lewis.  

Sainsbury’s appears to be caught up in the sluggish superstore trade over the summer months, albeit with tougher comparatives than Tesco.

Perhaps the most noteworthy component of the Kantar data is the sales performance recorded by Morrisons. Whilst Morrisons also has very favourable comparatives, could the change in trading strategy announced in March 2014, to a more simple value based offer, be starting to gain traction? Kantar suggests that sales fell 1.9% in the 12-weeks to the 18th August, a big surprise to us, suggesting potentially strong recent trade.

“Future economic and population growth projections for the UK may augur well for grocers at a strategic level”

Clive Black, head of research, Shore Capital

Sector comparatives are very favourable looking into forthcoming quarters. Additionally, future economic and population growth projections for the UK may augur well for grocers at a strategic level, noting that the incumbent players dominate the online channel.

However, inflation is easing and we need to understand the Tesco strategy, which could imply further industry gross-margin investment. We think that Tesco needs to invest to be merely in-line with the trade on pricing, as opposed to taking the sector to new lows.

With such a lack of transparency, we see downside support in what appears to be manageable trough earnings multiples for Tesco.

However, we are less relaxed about the group’s potential earnings-per-share growth on the other side of any reset, say to 2020. Clearly as market leader, a resetting Tesco has implications for the rest of the sector.

• Clive Black, head of research, Shore Capital