Just how tough is it out there? Despite warnings that wallets are being stretched by soaring inflation, the food retailer J Sainsbury PLC (LSE:SBRY) has reported strong Christmas sales and guided City scribes to adjust their profit forecasts to the top end of expectations.
While this guidance of £630mln to £690mln will still mean a fall in annual profits from last year’s £854mln, it still represents a solid showing given all the outside noise and especially when investments in product and staffing are taken into account.
Indeed, Sainsbury has found £550mln over two years to invest in price promotions to primarily tackle discounters Lidl and Aldi and also pumped £225mln into pay rises to support staff as they deal with rising prices and as the battle to retain key workers heats up.
The company has another lever to pull as well. Property could be sold and leased back meaning further cost and efficiency savings which John Moore, senior investment manager at RBC Brewin Dolphin, said gives it “the opportunity to keep pace with competitors and reinvest in product pricing”.
Margin call
Where this leaves margins – a topic of much debate - is uncertain.
Just how much are they being eaten away through inflation, price promotions and other investments?
There was no mention of them today but at the interim stage Sainsbury reported a drop in operating margins of 42 basis points year-on-year to 2.95%, still a relatively healthy number for a food retailer.
So pressure yes, but falling off a cliff, no. Indeed, cynics might suggest some companies have become skilled operators at using the underlying narrative of rising inflation, and food prices in particular, to hike prices more than has been absolutley necessary.
Orwa Mohamad, retail analyst at Third Bridge accepted “Sainsbury’s is fighting a rearguard action to maintain its gross profit margins” but is doing so “by carefully passing on extra costs to customers”.
Price differential with discounters closing
The challenge of the discounters will not go away either and as Mohamad comments “every day that the cost-of-living crisis persists lends greater strength to the likes of Aldi and Lidl as their store numbers grow and the stigma of using discounters melts away”.
But there may also come a time, we are not there yet, when all food retailers become discounters as the price battle continues and by nature of their extended product ranges, Sainsbury and number one food retailer, Tesco PLC (LSE:TSCO), reclaim lost market share.
Recent research from consumer champion Which? showed overall food inflation in 2022 was highest at Aldi over the year at 19.6%, followed by Lidl where overall inflation stood at 19%. Sainsbury at 13.7% and Tesco, 12.6%, lagged behind.
So part of this sacrifice in margins can also be attributed to a longer-term plan of reducing the price gap to the discounters. As the price differentials decrease, less investment should be required by those such as Sainsbury to retain their competitiveness, boosting margins and profits once more, and perhaps “we are all discounters now” will be the mantra of the food retail world.