Are Supermarket Stocks Worth Buying After the Crisis?

VIDEO: With Brits hoarding food like never before, supermarkets have seen unprecedented sales growth. But what's the long-term outlook for the sector? 

Holly Black 27 March, 2020 | 12:20AM
Facebook Twitter LinkedIn

 

 

Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Ioannis Pontikis. He is an equity analyst at Morningstar. Hello.

Ioannis Pontikis: Hello, Holly. Thanks for having me.

Black: So, one sector that I think is foremost on many people's minds in all of this is the supermarkets. There are queues outside them, people have been accused of panic buying. But from your perspective as an analyst, how do you think the grocers are responding to the coronavirus outbreak?

Pontikis: Yes, that's exactly right. As you just mentioned Holly, this is a panic. And this has led to panic buying. So, grocers try to make sure that there will be enough stock for supplies and basic necessities for everybody, which has forced grocers to introduce a rationing on virtually all grocery products so that more customers can buy them.

So, other actions that grocers are undertaking during these very challenging times is having tens of thousands of new employees to work in the warehouses and delivery operations so that they can cope with a significant spike in demand, both in stores and online. And finally, I think the majority of large supermarkets have pledged to reduce the time it takes to pay suppliers, especially the smaller ones, and ensure timely movement of food supplies through the system.

Black: So, a lot of this seems like quite a positive backdrop for the industry. What do you think the short-term implications are for these companies?

Pontikis: Yes. So, the main impact has been on top-line growth. This has been unprecedented with grocers that have reported numbers so far, commenting on plus 10% of plain growth. In some cases, such as Ocado Retail, more recently, more than 20% growth. So, some of this is obviously the result of people are working wrong form, essentially cutting all unnecessary social interactions. For instance, food out-of-home consumption is around £50 billion in the UK, or around £4 billion per month, with a good portion that currently being spent in food at home centers. So, supermarkets are expected to gain share as long as this crisis continues. But this should gradually normalise as life returns to normal, so in the quarters and probably months ahead. So, despite this unprecedented demand spike due to Covid-19 we expect forward buying to sort of unwind at some point and capacity constraints, in particular, delivery capacity, to limit sales growth in the next few quarters.

Black: So, it sounds like there will be sort of an initial spike where there is this unprecedented growth and then that will ease off. What are the long-term implications for the sector?

Pontikis: Yeah. So, I mean, in the past, we've talked about the two structural threats that the sector has been facing over the last several years now, namely, the increased penetration of online grocery, as well as the disruption by discounters. Now, from a Covid-19 perspective, online adoption rates should accelerate benefiting grocers with already developed and mature online and omni-channel offerings and technology providers that help grocers transition to more fully online.

Now, from a brand prospective, supermarket brands have a chance to shine again, but we don't foresee a lot of upside for grocers in terms of brand loyalty. Rather, I would say that there is a higher risk of brand damage in cases where grocers do not adhere to their typical services standards and this is especially important nowadays for the online channel. So, aspects of a channel or a service such as reliability, timely deliveries or even capacity to serve are crucial. So, now, from a more long-term valuation perspective, the materiality of this in terms of valuation is still uncertain, because that depends on the duration density of this crisis, both of which are still big unknowns right now.

Black: Okay. So, within that, are there any stocks you particularly like, are there any investment opportunities in this space at the moment?

Pontikis: Yeah. So, there are a couple of them. From the traditional grocery space, we see Tesco and Sainsbury's as better positioned to weather this crisis and transition to online. From the pure ecommerce space in Europe, we do like to Ocado. We think that a long-term investor in Ocado expects defensive characteristics. It combines exposure in both the online and grocery and markets, especially so in today's uncertain environment where the impact of this pandemic, long lasting or not, could result in even faster online grocery penetration in the years ahead.

Black: Ioannis, thank you so much for your time. For Morningstar, I'm Holly Black.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

About Author

Holly Black  is Senior Editor, Morningstar.co.uk