Amid bouts of panic buying and a surge in people cooking at home, Covid-19 lockdowns triggered a shift in the relationship between individuals and their local supermarkets – grocery stores were one of the few places where people were free to go.
During the height of the pandemic, the UK supermarket sector saw grocery sales soar; for example, alcohol (+ 27.6%), sweet foods used in home cooking (+23.5%) and snacks (+18.8%). Perhaps surprisingly, oral care was the only category that declined (-2.6%) during the period.
Where next for the Covid winners?
In the three months to 23 January 2022, UK grocery sales were down 3.8% from a year earlier, although sales across the sector are still up 8% against pre-pandemic levels (2019). January data from Kantar suggest that the slowdown in sales will continue as buying habits revert to their pre-pandemic norms, characterised by lower basket sizes and higher footfall.
Figure 1. Sales growth among UK supermarkets
Source: Kantar, January 2022
We expect the slowdown in grocery sales volume to continue through 2022 as Covid-related restrictions on the hospitality sector ease and people return to offices (flexible working is likely to keep sales above pre-pandemic levels into the medium term). However, as the sector emerges from the fog of one global crisis, it immediately finds itself on the frontline of another.
Negotiating rising prices
Having played a vital role during the worst months of the pandemic, the supermarket sector also finds itself at the sharp edge of the inflation crisis, which is widely expected to get worse before it gets better. With inflation hovering at the 5.5% mark in the UK, our senior economist expects prices to touch 7% before eventually declining over the latter half of the year. This trend will give rise to yet another shift in the pattern of the weekly shop.
So far, supermarkets are managing inflation pressures effectively. Suppliers and supermarkets are experiencing cost pressures, driven by high commodity and freight costs, a shortage of HGV drivers and wage inflation. These headwinds make them particularly vulnerable given the sector’s low margins. However, leading chains have been able to offset this through increased prices, cost savings and by working with suppliers. Tesco, the country’s largest supermarket chain, is experiencing cost inflation of around 5% and has identified £1bn of cost savings over the next three years. Sainsbury’s, the country’s second-largest chain, has raised its retail profit guidance by £50m, driven largely by volume but also by tighter cost controls.
According to Kantar, grocery price inflation reached 3.8% in January 2022 (and was 3.2% during the 12 weeks to 23 January).
Figure 2. Food inflation rate
Source: Kantar, January 2022
Tesco and Sainsbury’s reported that in the third quarter, food inflation was around 1%; this is below the market as both companies strove to maintain value perception. Having said that, Tesco’s Chairman John Murray Allan recently commented that prices of Tesco products could increase by an average of 5% in the coming months.
In our view, consumers will absorb these price increases by cutting down on non-discretionary spending, and shifting more towards private label products and promotions.
Private equity waiting in the wings: bad news for creditors
As these dynamics play out, the UK’s leading supermarkets have caught the eye of private equity (PE). Increased interest of PE funds in UK supermarkets is, ultimately, negative from a creditors’ perspective.