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FTSE 350 Outlook: Food retailers

Created:
24 January 2008
Written by:
Nathalie Olof-Ors

Economic downturns are normally the best time to hold shares in the food retailing sector. Indeed, shareholders can be assured that the tills will still be ringing at the supermarkets, even when other retailers struggle to attract customers into their shops. But this rationale might be tested in 2008 as this slowdown will probably expose the flaws in the supermarket defensive business model.

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Over the past few years, UK supermarkets have expanded rapidly into non-food. As always, Tesco led the way, and the group now sells a wide variety of products, ranging from clothing to garden furniture with the successful launch of Tesco Direct and the acquisition of Dobbies Garden Centres. And rival Sainsbury's has followed suit by significantly increasing its retail space dedicated to non-food products.

Logically, this means that these retailers are now far more exposed to weaker consumer spending than in previous economic cycles. Arguably, this could prove a sound diversification over time since stretched consumers are likely to hunt for bargains in their discretionary spend. But until this part of their business has proven its resilience, investors on the lookout for defensive shares might favour Morrison, which has stuck strictly to its food offer.

Nonetheless, 2008 could still be a favourable year for food retailers. First, food inflation will help to boost retailers' top-lines. And most analysts point to a strong historic correlation between inflation and supermarkets' performance. What's more, analysts insist that - despite weaker consumer spending - supermarkets are in a strong position to increase prices since food bills have considerably declined as a proportion of household budgets over the past few years.

Property transactions could be another driver for the sector. Although not much has happened so far on that front, Morrison still has 25 shopping centres and adjacent shops that could be sold off. Valued at around £1bn by the market, these property assets could wipe out the group's debt - which stood at £600m at the end of the first half. And as Citigroup analysts point out, this could significantly boost the cash paid to shareholders as some of the proceeds could be returned if the disposal goes ahead.

Company name Price (p) Mkt val. (£m) P/E ratio Div. yld (%) 12M price chng.(%) Last IC view
GREGGS 4293 453 15.2 2.89 -10.86 Fairly priced, 5,075p, 31 Jul 2007
MORRISON 311.25 8,360 24 1.3 9.69 Good value, 283p, 20 Sep 2007
SAINSBURY 383.75 6,688 22.4 2.7 -11.68 Fairly priced, 414p, 14 Nov 2007
TESCO 426.5 33,409 17.7 2.35 3.08 Good value, 454p, 24 Oct 2007

MORE FTSE 350 OUTLOOK SECTORS:

See also:

Pharmaceuticals & healthcare

Pubs

Food producers

Gaming operators

Transport

Real estate

For a full table of contents for the FTSE 350 Outlook series, click here.

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