The UK’s traditional supermarket giants are continuing to come under tremendous pressure, as the increased price competition from low-cost peers shows no signs of easing.
Research from Markit earlier this month clearly shows the strain investors are putting the sector under, with average short interest in the UK’s ‘big four’ listed grocery retailers surpassing 11% for the first time ever. But while the shelves might be empty in the UK, a number of fund managers have found the prospects for supermarkets more stocked elsewhere in the world.
An interesting theme for us at the moment can be found in UK supermarkets. In particular, the high yield names of Iceland and Tesco. As the UK market continues to undergo a quite severe price war, many of the incumbent participants in the industry have come under severe pressure recently.
Iceland, which had built up a niche in the low-cost section of the market, has found its position challenged by the likes of Aldi and Lidl, which are perceived as higher quality options in this low-cost space. Iceland could continue to face headwinds as competition intensifies in this market.
On the other hand, we have taken a position in Tesco which we purchased when it was downgraded at the start of the year. While now a high yield rated name, you need to remember it is still the largest UK supermarket chain, with a large number of attractive non-core assets it could potentially offload to fund its strategic objectives.
Our bearish stance on the UK supermarkets is well documented. The fundamental problem for the likes of Tesco and Morrisons is that their stores are the wrong size. If you look where the growth is coming from, it is not in the big stores – it is from convenience stores, discount shops or online outlets.
However, we have identified opportunities further afield, such as the North American supermarket Kroger. Its management seems to have long recognised the risks of the rapidly evolving industry and adapted. We see evidence of this in the disciplined stewardship of capital: high returns on capital, occasional acquisitions with higher incremental returns and growth. We see further evidence descriptively in its business model: retaining regional brands to cater to local taste; boosting general merchandise to counter Wal-Mart; staying in markets only where it has scale; using fuel as a loss-leader and increasing higher margin private label selection.
How do investors feel about Kroger? We have inferred they are sceptical. Kroger still appears quantitatively cheap. It has remained cheap despite years of surprising same stores sales growth, and crucially, growing market share. Analyst reports and news dwell on how poor the traditional supermarket model is, concluding that the good news must be unsustainable – just look at Tesco. These focus points in analysis have the look of bias.
French giant Carrefour is a fascinating situation. The company faced a similarly deflationary grocery market to what has been seen in the UK. Over the last ten years, the returns on capital for Carrefour have halved. Rival Leclerc has been very aggressive and has taken 2% or 3% market share away from Carrefour, but there has now been a stabilisation in the market.
The stabilisation has come on the heels of the restructuring introduced by Carrefour’s new chief executive. “The industry has seen a sale of non-core assets, a re-freshening of the hypermarket network – particularly in Brazil – and the introduction of click and collect. Organic growth is beginning to recover, even in the French business. Carrefour’s share price does not discount that recovery.
In the UK, we have a somewhat controversial and quite contrarian position in Ocado. It certainly is a more forward-looking growth stock, but it has enormous potential. The last major area of internet commerce yet to really penetrate the economy is the grocery market. If you look at books and clothing for example, these are segments seeing upwards of 50% market share from internet sales. Groceries are still only tiny fraction of this, well under 5%. The only company to master the technique and skill of selling grocery products online is Ocado.