Winners in grocery's great game

Last year was a muted one for the food retail industry, on the share price front at least - its defensive attributes meant the sector was a significant underperformer in a year when investors’ appetites had switched to more cyclical opportunities.

Only two companies finished the year in positive territory. One was Sainsbury, buoyed by the revival of speculation that the Qatari Investment Authority could be planning to build on its 27 per cent shareholding with a renewed approach for the whole company. The other was Booker, which used store makeovers and expansion of its internet channel to consolidate its position as the UK’s largest food wholesaler to convenience stores and caterers.

Booker’s performance was all the more impressive, given the continuing encroachment of major supermarket groups into the convenience retail space, an expansion which is set to continue over the coming year. Sainsbury alone is opening more than 1m square feet of new space in 2010-2011 as part of the largest space expansion in its history, which will include around 60 new Local stores. But it is not alone - Waitrose will open 300 'c-stores' over the next decade, M&S continues to add Simply Food branches, and Tesco is continuing to consolidate its own convenience position, recently announcing the purchase of 77 Mills stores to add to give it 600 One Stop branded outlets and 1,600 convenience stores in total.

It's important that Morrison, in particular, gets off to a good start this year after a muted Christmas, as its space growth plans are far more conservative than rivals' at around 500,000 square feet a year. Tesco plans to add 2.1m square feet of new space, and Sainsbury says that the bulk of the 20,000 jobs it plans to create will be in Morrison’s northern heartland. Morrison is buying 16 of the 47 smaller Netto stores being sold by Asda on the orders of competition authorities, but the company's chief executive Dalton Philips must surely accelerate plans for entry into convenience, online and non-food offerings if Morrison is to avoid being left a distant number four in the market.

Some analysts are worried that the scale of expansion - 25m of new square footage over four years - could prove problematic to the industry as a whole, pushing grocers towards an even more intense competitive environment and dampening like-for-like sales growth. It is estimated that promotional activity is currently running at around 35 per cent, and the launch of Asda and Morrison’s respective "Roll Back" and "Price Crunch" has led some analysts to wonder whether a margin-damaging price war is about to begin. Others, like Clive Black at Shore Capital, are more sanguine, suggesting this is simply new year "tub thumping" which is unlikely to result in longer-term margin erosion.

Even so, Booker is sensibly now broadening its horizons. As well as moving steadily into higher margin food service provision, it opened its first outlet in India in September 2009, and will add two others by the spring. Although the move takes it into competition with Tesco’s Star Bazaar venture in the country, there is plenty of room for both companies to tap into a vast market of 12m small grocery retailers.

Of course, India remains a long way short of Tesco's already vast operation throughout Asia Pacific, which is starting to deliver significant profits for the group despite China not yet breaking even. Former international head Philip Clarke replaces Sir Terry Leahy in March, and he will no doubt be looking to the rapid economic growth and favourable demographic trends in the Far East to offset of impediments to progress on the home front this year.

And there will be plenty of those to contend with, not least the financial pressure placed on households as living costs increase as a result of taxes and inflation. Rising petrol costs, in particular, are a problem as higher fuel bills are known to curtail expenditure on food. And although a return to a healthy level of inflation would be good news for supermarkets, which saw underlying sales moderate as a result of falling inflation in the first half, a spike in food prices as we saw in 2007 would be damaging to all, with the exception of hard discounters like Aldi and Lidl which would benefit if the current trend towards trading up suddenly swung back towards trading down.

BOOKER GROUP5990716.62.228.0
MORRISON (WM) SPMKTS.265703212.23.2-10.6
OCADO GROUP1901,0520.0
SAINSBURY (J)3827,11916.03.815.4

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