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Britain’s three largest supermarkets took the top spots on the FTSE 100 on Tuesday morning, after a report by Goldman Sachs suggested some of the recent pressures on the sector should soon start to ease – though the bank was at pains to stress that the picture is still far from rosy.
Tesco was the biggest riser, with its shares gaining 4 per cent on the back of a double upgrade from the long-bearish Goldman. The bank also upgraded its recommendation on Morrisons, and increased its target price (but maintained a “sell” rating) on Sainsbury’s. Shares in Morrisons rose 2.8 per cent, while Sainsbury’s climbed 3.1 per cent.
Supermarkets have traditionally benefited from higher inflation, which allows them to boost profit margins by passing on price increases to customers, while using their purchasing power with suppliers to limit their own costs. However, the rise of discount outlets Lidl and Aldi has prompted intense competition in the sector, making companies wary of raising prices despite inflation reaching a five-year high.
As a result, input prices have been rising more quickly than consumer prices for the longest period on record, according to Goldman, putting serious pressure on profit margins.
But the gap between input cost and food price inflation has now narrowed to its smallest level in more than a year, and the bank thinks the pressure is likely to ease further in the months ahead. It says even discounters like Aldi are now passing on costs to consumers, encouraging more “rational” pricing behaviour across the sector that will create a “more constructive margin environment in UK grocery in 2018 vs 2017″.
As the biggest incumbent with the most ambitious cost-cutting plan, Goldman’s analysts reckon Tesco will be the biggest beneficiary of the trend, allowing it to gain market share from the rest of the “big four” even as Aldi and Lidl keep growing.
Still, while investors were clearly encouraged by Tuesday’s report, Goldman stressed (repeatedly) that Tesco and its peers still face some serious challenges ahead:
While we are positive at the margin, we still believe the UK is a structurally challenged market and forecast long-term EBIT margins and returns well below pre-2014 levels …to be clear, we are not saying the UK grocery market is now attractive …as we note above, we are not saying all is rosy.