UK Grocery Market Prospects

In this report we look at the UK supermarket sector and its prospects for the rest of 2015. It’s been an interesting year so far, with the big four – Tesco (TSCO), Asda, J Sainsbury (SBRY) and WM Morrison (MRW) – facing continued stiff competition from rampaging German discounters Aldi and Lidl. We’re even seeing attempts at making frozen food cool again begin to bear fruit with the likes of Iceland stepping up to the mark to maintain pressure on the bigger guns.

The UK consumer is much scrutinised as an economic barometer, but never so much as to gauge the health of the general retail sector and this makes the supermarkets some of the less cryptic stocks in the UK 100 . Drivers tend to be much closer to home – think inflation, average earnings, consumer sentiment and interest rates – even if the supermarkets have their fingers in pies much further afield.

Supermarkets are still the big players

As the above chart shows, despite impressive sales growth in 2015 (Aldi +18%, Lidl +13%), the discounters have a long way to go before they pose a really serious challenge to the UK’s big four supermarket chains in terms of sales value. What they have flagged up, and what the supermarkets missed early on, is a general public that’s become much more cost-conscious and less self-conscious post financial crisis.

Additionally, no longer is Iceland seen as a pusher of sub-standard, cheaply produced frozen goods while a large portion of the Barbour-wearing, dog-walking middle classes have all but jumped into bed with Aldi and Lidl, heaping so much praise on the German discounters it’s not uncommon for cries of ‘get a room!’ to traverse reception rooms at Christmas drinks parties.

What will it take to tempt customers back to the traditional heavyweights? One observation we may make right now is that Tesco (TSCO), J Sainsbury (SBRY) and WM Morrison (MRW) are all facing their own bespoke challenges in addition to battling the common foe in the discounters.

Discounted disruption

As the price war continues to rage with grocery price inflation now at -1.7% year-on-year (otherwise known as deflation) it’s no wonder the growth of the sector at large has suffered. With the relentless rise of competitors with sales growth figures in the mid-teens, it’s clear some form of re-balancing is taking place, and research by Kantar Worldpanel suggests we could be heading for a ‘new normal’ of low yet steady industry growth.

In terms of market share, the discounters unlikely to be really testingTesco, snapping at Sainbury’s heels or marking time with Morrisonsin the near future, but it is interesting to note that Aldi has overtakenWaitrose in terms of market share – a stark reminder of the clout they increasingly carry in the market.

So the questions we must ask of the UK’s (still) leading supermarkets are:

• Which of the big four will adapt quickest to this ‘new normal’?
• Which has the fewest skeletons in the closet?
• Which is ripe for acquisition?

WM Morrison (MRW)

M&A deals continue to pop-up with predators making the most of a low interest rate environment and discounted valuations and it was most recently the turn of middle-of-the-road WM Morrison (MRW) to attract attention as a potential candidate for acquisition after South African billionaire Christo Wiese, whose $25bn investment vehicle recently bagged a 19% stake in grocery chain Iceland (as well as stakes in New Look and Virgin Active), said he was interested in the UK’s supermarket sector and had a billion or so left to deploy. A continental supermarket deal between Dutch Ahold (AMS) and Belgian Delhaize (DELB) has also focussed the spotlight this year.

Short Interest: 12.57% (source: Short Tracker; 16 Sept)

MRW closing prices, daily

Will the price head up towards 24-month highs 300p, or, will it fall back towards lows of 152p?
Broker Consensus: 26% Buy, 35% Hold, 39% Sell

Most Bullish:             Nomura, Buy, Target 280p, +77%

Consensus:                                       Target  178p, +12%

Most Bearish:            Bernstein, sell, Target 140p, -12%
NB: All pricing and consensus data from Bloomberg on 16 Sept; Consensus breakdown available on request 

Tesco (TSCO)

An already heavily discounted $15.1bn price tag on Tesco (TSCO) puts it beyond the reach of South Africa’s Mr. Wiese for now, but the company is in the midst of major restructuring to cut its £22bn debt-ridden balance sheet by selling major assets. While this has thus far proven a thorn in ‘drastic’ Dave Lewis’ side, the £4bn offloading of South Korean Homeplus confirmed in late August will be welcomed by shareholders. The turnaround from the woes that began in 2014 has been slow at picking up, but could a long awaited sale of Tesco’sDunnhumby data unit (which runs Clubcard) confirm a turning point that attracts fresh investors to the stock?

Short Interest: 0.70% (source: Short Tracker; 16 Sept)

TSCO closing prices, daily

Will the price bounce up towards 27-month highs 385p or will it pull back beneath lows of 165p?
Broker Consensus:       37.5% Buy, 37.5% Hold, 25% Sell

Most Bullish:                         HSBC, Buy, Target 295p, +65%

Consensus:                                                Target 217p, +21%

Most Bearish:    JPMorgan, Underweight, Target 150p, -16%
NB: All pricing and consensus data from Bloomberg on 16 Sept; Consensus breakdown available on request

J Sainsbury (SBRY)

Sainsbury’s is the only UK supermarket to have seen a month-on-month increase in sales (+0.1%, first growth since March) in the latest Kantar data, represents the quiet one of the three as regards major shake-ups and restructuring and is unlikely to be a target for M&A (unless from the Qataris who already own a 25% stake). Asda’sgreater focus on non-foods makes it traditionally stronger during the summer, and it’s expected that the Wal-Mart-owned chain will surrender its current No. 2 slot to Sainsbury’s towards Christmas 2015.

Short Interest: 9.57% (source: Short Tracker; 16 Sept)

SBRY closing prices, daily

Will the price rally towards 345p or will it fall beneath lows of 224p?
Broker Consensus:                     32% Buy, 32% Hold, 36% Sell

Most Bullish:               Bernstein, outperform, Target 330p, +42%

Consensus:                                                      Target 245p, +6%

Most Bearish:   Goldman Sachs, sell/neutral, Target 155p, -33%

NB: All pricing and consensus data from Bloomberg on 16 Sept; Consensus breakdown available on request