It's fair to say that 2014 was a disaster for the UK's listed supermarkets. Discount grocers Aldi and Lidl continued their forward march, nibbling away at the market share of the big three - J Sainsbury (SBRY), Tesco (TSCO) and WM Morrison (MRW) - while Waitrose and M&S moved in at the top end. What ensued was a bloodbath: quarter after quarter of sales declines and the worst trading in the history of both Tesco and Morrison. This sparked a fierce price war which is still raging. Meanwhile, the chief executives of all three grocers have either been sacked or left the business - Morrison's Dalton Philips was the last to be shown the door, hot on the heels of Tesco's Philip Clarke. Sainsbury's Justin King, however, stepped down on his own terms.
Morrison has been hit particularly hard by the discounters, given its bigger exposure to lower-income shoppers. The supermarket's strategy has also seemed muddled. Slow to catch on to loyalty cards and convenience and online shopping, its plan to make stores more upmarket failed to attract shoppers. Moreover, it sold off childrenswear business Kiddicare in May for £3m - having bought it for £70m.
But Morrison's woes now pale against those of Tesco. The overstretched supermarket reached breaking point when the new management team, led by Dave Lewis, revealed that Tesco had overstated its half-year trading profit by hundreds of millions of pounds, reflecting some creative accounting in the UK food business. Full-year profit will be half of last year's and it's widely expected that the UK trading margin will fall to zero. Ignoring its UK stores, to focus on expanding overseas - where growth failed to materialise - was arguably its biggest failing, though. It also invested in unnecessary peripheral businesses, including coffee shops, bakeries and video streaming.
To turn the business around, Mr Lewis has announced major cost-cutting, asset sales and the halting of expansion. He cut the dividend, too, and Tesco will also slash prices further in an effort to lure back shoppers who have defected elsewhere. But that turnaround won't come easy as the problems blighting the sector continue into 2015. Tesco and Asda are going head-to-head in another round of price cuts in a mature market with significant overcapacity, leaving growth prospects looking feeble. True, as the oil price tumbles consumers may well have more to spend, but it's debatable whether they'll spend it on buying more food.
With the battle lines drawn, Julie Palmer, a partner at Begbies Traynor, reckons the supermarket price war is only intensifying. "In recent weeks, Asda and Sainsbury's have promised £450m-worth of price cuts between them, Morrison has started a search for a new CEO who can return them to growth, while Tesco has set out major plans to reassert its dominance over the UK grocery market. With mini-supermarkets on every corner and Aldi and Lidl opening local shops as fast as they can find the sites, competition among food retailers on the high street is still rife."
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Still, the supermarkets did fare better over Christmas than many had expected, prompting a significant share price rise at all three. The volume of items purchased from the UK's leading food retailers increased year on year for the first time since mid-July 2013, according to data from global information and insights company Nielsen. Sales volumes actually increased 0.6 per cent in the four weeks to 3 January 2015. "Much has been made of people spending less in supermarkets, but little attention is paid to how much they're buying," says Mike Watkins, Nielsen's UK head of retail and business insight. "The fact they're starting to buy more - driven by confectionery, snacks, drinks, fruit and veg, and delicatessen - is a bright start to 2015 for the major supermarkets."
According to Nielsen, Morrison had the best Christmas. However, if you look at the data covering the 12-week period to 3 January 2015, Waitrose (up 7.7 per cent), M&S Food (up 1.3 per cent), Aldi (up 20 per cent) and Lidl (up 14 per cent) were the only grocers to report year-on-year sales increases.
With sentiment seemingly more positive, but with growth hard to deliver, it's still probably too early to tell whether the food retailers offer any sort of recovery potential. Christmas comparatives were easy and a stream of earnings downgrades leave valuations looking stretched. So any disappointments with like-for-like sales or profit margins at any of the supermarkets could put shares under pressure.
| Company name | Share price (p) | Market value (£m) | PE ratio | Dividend yield (%) | 1-year performance (%) | Last IC view |
| Booker Group | 157 | 2,761 | 25.1 | 2.0 | 3.2 | Buy, 121p, 17 Oct 2014 |
| Greggs | 841 | 850 | 24.2 | 2.3 | 66.1 | Hold, 830p, 15 Jan 2015 |
| WM Morrison Supermarkets | 195 | 4,553 | 11.5 | 6.8 | -22.0 | Hold, 185p, 14 Jan 2015 |
| Ocado Group | 415 | 2,428 | NA | 0.0 | -21.3 | Hold, 357p, 1 Jul 2014 |
| J Sainsbury | 264 | 5,054 | 8.6 | 6.6 | -27.9 | Hold, 256p, 12 Nov 2014 |
| Tesco | 229 | 18,602 | 9.6 | 4.9 | -30.5 | Hold, 202p, 13 Jan 2015 |
| Supermarket sales per square foot per week (£) | |||||
| 2010 | 2011 | 2012 | 2013 | 2014 | |
| Tesco | 25.2 | 24.9 | 24.8 | 24.1 | 23.3 |
| Sainsbury | 20.4 | 20.0 | 19.4 | 19.2 | 18.9 |
| Morrison | 22.4 | 22.3 | 22.5 | 24.7 | 24.4 |
Favourites
Ever reliable Booker (BOK) is proving resilient against falling food prices and its acquisition of Makro will lead to significant market share growth and cost savings. The shares did come under pressure amid the sector's wider problems, but we saw that as a buying opportunity and tipped the shares mid-year (126p, 31 Jul 2014). Baker Greggs' (GRG) food-to-go strategy appears to have been a resounding success with shoppers, too, and the group has seen phenomenal growth - despite being focused on a highly competitive segment of the food market. Profit margins are growing and customers are returning, while deals with motorway service stations offer a further reason to be positive.
Outsiders
We'd avoid all of the listed supermarkets at present. Admittedly, WM Morrison could become a private equity takeover target, while Tesco may yet turn out to be this year's biggest recovery play. But with so much uncertainty, and given the structural challenges ahead, the big three have few attractions for now.
