FTSE 350: Grocers never waste a crisis

One crisis looks to be nearly over, but grocers are now facing another sensitive issue: how to handle the cost-of-living squeeze. With inflation running hot and wages struggling to keep up, the Office for Budget Responsibility has predicted that this year will see the biggest drop in living standards for more than half a century. Energy costs have been burning the biggest hole in consumers’ pockets, but there is a food element too as supermarkets raise prices to reflect the higher cost of energy, labour and now wheat. 

So far, these pressures have not dented the sector: Tesco’s pre-tax profits tripled to £2.03bn in the year to the end of February, while Sainsbury’s swung back to a £541mn profit in the six months to September. Even so, last-12-month PE ratios are the lowest they have been in years.

Yet lean years for consumers often mean fatter profits for supermarkets, which have the ability to raise prices while keeping their own costs under control thanks to their dominant position in the supply chain. Grocers’ notoriously-low margins crept steadily upwards in the three years following 2008, for instance. Even if retail profitability declines as a result of mounting cost pressure, as Tesco has cautiously guided, supermarkets’ history of stable cash generation and large asset bases could become an advantage over discretionary retailers in the year ahead.

But it is a fine balance, particularly if consumers start trading down. Data from Kantar shows that German discounter Aldi has grown its market share to 8.6 per cent this year, up from 7.8 per cent just three months ago, and this looks likely to keep rising. However, there are reasons to believe that might put less pressure on prices than in the past. Private equity has taken control of two of the ‘big four’, Morrisons and Asda, in the past two years. Their new owners have saddled them with higher debt loads that could make price cuts trickier. 

Another area of interest is the prospect of lasting changes to consumer behaviour. Online shopping’s share of the market has risen to 9 per cent, compared with 5 per cent pre-pandemic, according to the Office for National Statistics. The current figure is already significantly lower than its pandemic peak, which has helped undo some of online-only grocer Ocado's (OCDO) share gains. Still, rapid grocery delivery has become a huge market, with Turkish unicorn Getir recently valued at $12bn (£8.8bn). Sainsbury's and Tesco have both launched their own 60-minute delivery services, positioning them well to take on shifting customer preferences.