- Supermarkets counting profits after record Christmas spend
- Cautious shoppers trade down but outlook remains positive
Christmas trading updates revealed a festive sales boost for the major supermarket chains, and despite cost pressures and shoppers trading down, profits are set to remain healthy.
City analysts see net income declining only slightly at Tesco (TSCO), J Sainsbury (SBRY) and Marks & Spencer (MKS) over the next two years, as per consensus estimates compiled by FactSet, although 2022 will remain a high-water mark.
This comes at a difficult time for UK consumers at the tills. The Resolution Foundation think tank said this week that food insecurity levels have tripled against the pre-pandemic baseline. And Ocado’s (OCDO) confirmation that annual sales at its retail joint venture with Marks & Spencer fell for the first time came after shoppers bought fewer products.
It is in this challenging context that the grocery giants are trying to perform a balancing act. They are aiming to keep a lid on prices to maintain market share while also holding onto margins and keeping investors onside.
Margins are key for the latter – the higher these are, the more cash is available for dividend payouts and for investment. Analysts expect Sainsbury’s, which has a higher dividend and free cash yield than its peers, to pay a 13p-a-share dividend for the year, the same as 2022. Tesco’s full-year results are first up on 13 April, with Sainsbury’s announcement following later in the month.
Keeping control of costs
Exane BNP Paribas analyst Andrew Gwynn told Investors’ Chronicle that “the most striking theme” from Tesco and Sainsbury’s trading updates was the control they have managed to keep over costs, “despite what at times seems a chaotic situation” in the market.
This control was reflected in outlook statements. Both Marks & Spencer and Tesco maintained full-year guidance, with the latter forecasting a retail adjusted operating profit of £2.4bn-£2.5bn. Sainsbury’s, meanwhile, said its annual retail cash flow would be £100mn more than expected and that profits would come in at the higher end of its guidance range of £630mn-£690mn.
Marks & Spencer, which outperformed its listed peers in top-line growth rate terms in its third quarter, seems keenly aware of the political side to solid sales numbers: it said it would open 20 new UK stores, and highlighted the 3,400 jobs this could create.
Peel Hunt analysts said of Marks & Spencer’s update that "there are no material incremental pressures on margins (versus expectations)”. The broker expects the company’s adjusted cash profit margin to fall from 11.6 per cent in 2022 to 10.1 per cent this financial year.
Market leader Tesco and peer Sainsbury’s reported similar rates of non-fuel retail sales growth in the six weeks to 7 January. Sainsbury’s subsequently proclaimed a deal with food delivery technology app Just Eat (JET) which will aim to deliver items to customers within half an hour, pointing to optimism that some customers will value convenience over value.
But sales growth is rising by less than the rate of inflation, which highlights the move to cheaper products. Data consultancy Kantar said that December grocery sales volumes fell by 1 per cent against 2021, with sales of own-label goods at supermarkets up by 13 per cent compared with a 5 per cent increase in branded products.
Margins are under pressure
Margins are also under pressure due to the growth of the discounters. Sales at Aldi and Lidl, which now take over 16 per cent of grocery market share, were up by around a quarter in December.
Shore Capital head of consumer research Clive Black said that the discounters have gained “unnatural business” due to cost of living pressures and argued that they will face “very tough comparatives” next January if the consumer spending situation has improved.
Gwynn, meanwhile, said that “the battle with Aldi and Lidl will be characterised by a lot of price following, market share gains for the discounters but ultimately, not too damaging to earnings [for the listed grocers]”.
We maintained our recommendations on the grocers after their recent updates – we have a hold on Marks & Spencer and Sainsbury’s, a buy on Tesco, and a sell on Ocado. Festive trading was resilient enough, although we remain wary of margin pressures and have highlighted the limited detail on inventory.
But if inflation falls this year, as is expected, there could be a positive knock-on effect on margins. Although trading down is hitting profitability, Black said that Shore Capital “expects relatively stable margins” in 2024 against 2023. And he added that there is “some risk on the upside if living standards are on the rise in a year’s time”.
