The struggles of established British supermarkets are well-known, but some are finding their niche in the new order.
Tesco has long been synonymous with British retail, but in recent years a combination of innovation, technology and cheaper alternatives has threatened the supermarket’s long-accepted supremacy, and squeezed its profit margins.
In December last year, Tesco’s share price hit a low it had not seen since 1997. By that point, it had forfeited more than two thirds of the value it held at its peak in September 2007.1 Although some of the initial slide could be attributed to the financial crisis, changes in the retail sector have imposed more lasting damage, and Tesco was slow to adapt.
“Tesco’s prices became too high, its service levels were poor, it grew complacent, and a gap opened up for more nimble competitors,” says Nick Purves of RWC Partners. “The share price fall was justified.”
Nevertheless, when it comes to e-commerce in Britain, Tesco is still able to claim second place, with revenues in 2015 of £2.9 billion, according to Retail Week; Amazon sits at the top of the list with annual revenues of £4.4 billion.2
Moreover, when it comes to UK retail more broadly, Tesco remains top dog. Its sales for the 2014/15 financial year were £43.6 billion, almost double that of Sainsbury’s, which sits in second place. 3
These different indicators are a reminder of two important trends for UK supermarkets. On the one hand, technology, innovation and competition are squeezing margins. On the other, since food retail volumes don’t change dramatically, even in downturns, those players that adapt can still enjoy a profitable future.
“It is unlikely profitability will ever return to what it was and the shares have fallen as a result, but the businesses can recover,” says Purves. “In our view, Tesco is challenged but not fundamentally broken. It’s changing quite quickly, and it’s important to differentiate between change and breakdown: discounters have appeared, as have new consumer tastes, and there is some shift to internet sales.”
With its origins in Hackney, North London in 1911, Tesco can point to history as proof of its ability to survive and prosper. But its Bradford-based rival, Morrisons, goes even further back. Founded in 1899 as an egg and butter merchant, the company is still part-owned by the Morrison family. Twelve years ago, it acquired Safeway and, at the end of 2015, it held an 11% market share in the UK grocery market. That is some way below Tesco’s 28%, but Morrisons may have significant potential to improve its standing.
“It’s been poorly run almost going back to the days of the Safeway acquisition,” says Richard Colwell of Columbia Threadneedle “So it follows that if the new management team can get to grips with the business, there is so much more upside.”
The company began trialling a new in-store management structure at the beginning of 2013, which it claimed gave customers greater access to members of staff. The company closed seven unprofitable stores in January, and has sold some 140 ‘M local’ outlets in recent months. Such moves are designed to keep the supermarket chain focused on profitability, and reflect the new impetus created by the management team that took over at the start of 2015.
“It is early days, but we’re encouraged by the progress so far, in terms of being very decisive strategically by exiting the convenience stores and making the loyalty cards clearer,” says Colwell.
“The company is also really focusing on generating cash flows, which is the start for any kind of recovery in the industry,” says Colwell. “So the balance sheet is getting stronger and then operationally they’re trying to instil some much-needed energy back into the stores and gradually attract customers back.”
Please note that past performance is not indicative of future performance. The opinions expressed are those of Nick Purves of RWC Partners and Richard Colwell of Columbia Threadneedle and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or by St. James’s Place Wealth Management.
1 Yahoo Finance, accessed 21 April