When Britain was put into coronavirus lockdown to limit the spread of the pandemic, and the government reassessed the country's key workers, no-one batted an eyelid at the inclusion of supermarket cashiers, shelf stackers and grocery delivery drivers.
“There has been a fundamental reassessment of the importance of grocery retailers,” agrees Justin King, ex-chief executive of Sainsbury’s and a current non-executive director at Marks & Spencer.
“A regular part of our lives that had been taken for granted is now understood to be a core part of our national infrastructure with robust supply chains, staffed by dedicated key workers.”
The emergence of supermarkets as a previously underestimated core industry has not gone unnoticed by some investors, but financial markets are still painting with a very broad, red brush.
Shares in the major supermarkets, along with other retailers that sell food and investment funds that specialise in the grocery sector, are all priced well below their levels from the start of the year despite some of them experiencing weeks of their strongest ever trading.
King says the realisation of the importance of the industry may represent a “structural shift”, suggesting that a ‘new normal’ could persist once the virus dampens down, if it ever truly does.
The change in mindset both among the public and in the City of London “is real”, says Clive Black, head of research at Shore Capital, which he says is driven by the recognition that “we are in a near wartime mentality”.
“Feeding the nation, food security, are to the fore and check-out assistants and shelf-packers are the food troops,” he says.
Nick Bubb, an independent retail analyst, is of a similar mind.
“The switch from eating out to eating in will boost demand for supermarkets for some time to come — and in the medium-term I think there is a strong argument that the big food retailers should be re-rated upwards for their defensive and community focus,” he says.
Stockpiling, rationing and government support
The dawning of this new mindset may have come last month, with some supermarket’s shelves cleared of toilet paper, hand wash and pasta, or early this month in reports that the industry had drawn up a plan to work with food suppliers to ensure supplies of staple products are maintained even if the coronavirus epidemic escalates badly.
The war footing was soon confirmed as major grocers were forced to start rationing some products to try and limit stockpiling, while online delivery slots were snapped up as the public’s worries worsened.
On the same day that the government announced a 12-month business rates holiday for various key industries, Wm Morrison Supermarkets PLC (LON:MRW) was the first of the big supermarkets to put its head above the parapet and reveal how the panic buying was affecting business.
The Bradford-based group, having struggled with falling sales last year, said sales had improved to flat sales in the first four weeks of the current year and with growth accelerating to 5% over six weeks.
Morrisons, which said it was taking on 3,500 extra staff to cope with the rush, confirmed sales had taken off from customers stocking up and ‘sales pull-forward’.
Anecdotally, a perspective from the likes of Sainsbury’s (LON:SBRY) and Tesco (LON:TSCO) is that some larger stores have been seeing like-for-likes sales jumps of up to 50% in the last couple of weeks, says Steve Windsor of Atrato Capital, the investment adviser to Supermarket Income REIT plc (LON:SUPR).
“That’s like a Christmas trading week, every week. That’s unprecedented.”
While the government rushed to hold talks with industry executives to verify how potential shortages can be managed during the outbreak, as well as ensuring deliveries for shoppers that were in self-isolation, preparations for such a scenario have been in place for some time.
Not only have supermarkets been ‘wargaming’ for a potential pandemic for years, but as good or bad luck would have it, almost all companies in the industry have been preparing for potential stockpiling scenarios for Brexit over the past year.
Big grocers have run such war-games two or three times with scenarios of empty warehouses, supply chain issues and mass stockpiling, says Windsor.
Empty shelves are inevitable, adds King, who is also a special adviser to Supermarket Income REIT among his portfolio of roles.
“Over the last two weeks people have bought forward or stockpiled around a week's extra sales, causing short-term availability issues of key lines,” he says. “This will abate, and availability on all but a few lines should recover quickly.”
“It should be remembered that prior to the crisis around 30% of total calories were consumed from food service providers and while this sector is largely closed this food shopping will shift to supermarkets. This is why we are seeing recruitment announcements from them all.”
Tying in with fresh media reports on Thursday about the security of food supplies, ShoreCap’s Black agrees that they “remain sound”.
“We can never say never but there should be no need to panic, after recent weeks larders are probably quite full, so a quieter week four is anticipated albeit total lockdown has yet to be absorbed.”
Ocado and the problem of online capacity
Out of all the UK grocery sector, Ocado PLC (LON:OCDO) has been priced by stock market as a bigger beneficiary than the big four supermarkets or in fact almost any company.
It's understandable, as Ocado was one of the first companies to flag a surge in demand, sending an email to customers last month advising that delivery slots were filling up faster than usual, and later shutting down its website and app as all delivery capacity had been sold out.
However, a trip to the websites of Tesco, Sainsbury’s, Morrisons or Asda will generally also find no delivery slots available as the coronavirus lockdown makes trips to the grocer difficult for most or impossible for those on self-isolation.
“The market has clearly seen that online will be a big beneficiary,” says King.
“This is true but as it accounts for around 7% of the UK grocery market even a doubling of online capacity will not be able to take up the majority of this structural shift.”
Even in the past two weeks as the country started to go into lockdown, it is estimated that over 85% of grocery volumes are still being purchased in-store.
Black goes further: “online is capacity constrained and found wanting in this crisis. It is peripheral to the mass effort even though it is seemingly perfect for social lockdown.
“If the dust settles, I sense online will gain share gradually — it is a very costly and low margin activity.”
Analysts at Berenberg also expect the effect will last, predicting a “permanent step-up” in online grocery penetration across the industry, as more households have rapidly adapted behaviour and signed up to one or more supermarket online offers.
Not so super market valuations
Compared to Ocado’s shares, which at one point last week were up 15% since the start of the year, Tesco’s, Morrisons and Sainsbury’s shares are down 13-14%.
While grocers are among the best performers since the crisis started to break, there still seems to be a large dislocation between price performance and the underlying store performance.
Traditional defensive sectors like utilities, healthcare and personal and household goods have fallen even less, though it is arguable which of them may do better in the coronavirus-stricken economy.
Looking back to the stock market reaction in 2008, initially the whole market sold off with no differentiation between winners and losers, and analysts across all sectors are trying to do that now.
That differentiation is starting to happen, but with the full economic fallout from the virus still very unclear, especially in the UK, that moment could still be some way off.
Investors who can face the risk of potential hurdles along the way, however, will be keeping an eye on the food retailers as a potential opportunity.
Tesco shares are down 13% to 221.5p so far in 2020, despite what may turn out to be the strongest sales in the company’s history in recent weeks, as well as a balance sheet poised to be strongest its ever been, with the agreement to sell its Thai business for US$10.3bn and pay a large chunk back to investors.
On top of that, Tesco may also benefit from around a £900mln boost if the government confirms that the business rates holiday extends to supermarkets, with Sainsbury's also saying it could save around £500mln, but neither Morrisons nor Asda having put a number on it yet.
Sainsbury’s, while not enjoying the same balance sheet clout as the market leader, has seen it shares slip 13% in the year to date to just under 202p, having been down 24% before the FTSE spike this week. For Morrisons, the dropped has been 14% to just below 174p.
Supermarket Income, an investment company that has an expanding portfolio of large Tesco, Sainsbury’s and Morrisons stores with long unexpired lease terms, has outperformed its tenants, with the shares dipping 12% in the year to date.
The REIT’s offers a dividend yield over 6% and, unlike many larger names in other sectors dumping dividends in recent days, the board is highly unlikely to cut the dividend at all with tenants doing so well.