A damning new report on UK supermarkets has warned the emerging sense of investor optimism about the sector will soon be over as retailers have yet to cope with structural decline.
Instigating coverage on the UK food retail space, analysts at Credit Suisse predict the share price “honeymoons” Tesco and Morrisons have experienced will be a temporary respite. “We worry the CEO honeymoons will be over soon. Shareholders will then be forced to confront the cold reality of misallocated capacity, continued competitive pressures and stagnant growth,” they warn.
The broker has placed underperform ratings on Tesco and Sainsbury’s, issuing a price target of 169p (currently 214p) and 219p (currently 259.2p) respectively. Morrisons was given a neutral rating and a 176p target price (currently 177.1p), though Credit Suisse expects “further sales declines in the face of continued competitive pressure”.
“Finetuning existing operations will not be enough to resuscitate the sector,” the report warns. “Major product rationalisations, shutting/selling underperforming stores, radical lease renegotiations, the dissolution of national pricing, and business combinations are all possibilities within the UK grocery industry.”
The “extreme competitive pressures” and “very low-growth environment” will see the big four’s market share erode further, Credit Suisse predicts. “Recent market share data have been mildly encouraging for the incumbents, but defending market share has been expensive. And it’s not over yet.”
The most recent Kantar Worldpanel market share figures cited by Credit Suisse have the combined big four market share at 64.9%, with Tesco leading on 25.5%. Credit Suisse expects this share to erode further by 2021 despite the recent stabilisation, with the combined share dropping to a historically low 58.6% and Tesco’s share falling by 2.9 percentage points to just 22.6%.The aggregate share of the top 11 grocers is likely to remain unchanged at 89% by 2021 as the discounters grow to claim 12.2% of the market (with Aldi’s share up 67% and Lidl’s up 50%) from their current 7.6% share and strong growth amongst the more premium players (Waitrose, M&S and Ocado) to 11.9% of the market from 9.2%.
The stress the major grocery players are under could lead to defensive M&A activity in the sector, Credit Suisse predicts.
“The weak operating environment could force consolidation within the industry, as we have seen in previous times of stress,” the broker says.
One potential bright spot for the beleaguered industry is the growth potential of online, with Ocado set to reap the benefits.
Credit Suisse gives Ocado’s shares an outperform rating and a target price of 466p - 20% higher than it was at the time the research was published.
“Its unique business model and lack of legacy issues make it a formidable competitor to the incumbent grocers,” Credit Suisse said. “The bulk of Ocado’s potential value resides in its ability to sell its infrastructure solutions to multiple parties. Initially, we expect grocery distribution agreements similar to the Morrisons contract, but other forms of agreements are also possible.”
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