Why UK supermarkets are not making super profits

For an industry known for wafer-thin margins and cut-throat competition, UK food retail has benefited from a tide of good news in recent weeks.

Industry data have shown Tesco and J Sainsbury taking market share from hard discounters such as German rival Aldi for the first time in years.

Food price inflation is back in positive territory and the enforced closure of pubs and restaurants in the UK has diverted spending on food outside the home to consumption within it.

Although supermarkets continued trading throughout lockdown, they still benefit from the government’s business rates holiday, delivering savings of well over £1 billion (€1.1 billion) across the industry.

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Staff at Bewley’s cafe on Grafton Street are made redundant

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Irish shoppers continued to stockpile as lockdown came to a close

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And online sales have boomed. Ecommerce capacity has more than doubled, with Tesco and Sainsbury alone adding capacity equivalent to two Ocados since March.

Yet all three UK listed grocers – Sainsbury, Tesco and William Morrison – have said they expect little or no full-year profit increases as a result of the pandemic.

Why not?

Sainsbury chief executive, Simon Roberts, on Wednesday warned that coronavirus-related costs were "very significant", hitting profit by more than £500 million this year.

Tesco said its additional costs would be “towards the upper end” of its previous £650 million to £925 million range.

By far the most significant of these has been staff.

Tens of thousands of new workers have been hired to increase online capacity and to cover for those who were self-isolating, often at full pay, while all the supermarkets paid store staff a bonus during the stockpiling phase of the pandemic.

At the peak of the outbreak, 52,000 of Tesco’s staff were off work – almost a sixth of its UK headcount. It expects extra staff costs to add almost £300 million to its overheads this year.

Absenteeism is now falling, but other costs associated with more ecommerce and changes to store operating processes, such as increased cleaning, will persist in the second half.

Wrong type of sales

In terms of profitability, what supermarkets sell is as important as how much they shift, according to Shore Capital analyst Clive Black. Lockdown has meant that office staff and commuters are eating low-margin staples with their families at home, rather than buying high-margin sandwiches or ready meals.

Kantar estimates that sales of food and drink on the go, worth £347 million to supermarkets in June 2019, were down by one-third in early June this year.

Traditional supermarkets also have more branded goods in their sales mix than discounters, meaning more profit is shared with the brand owner.

And sales of some non-food lines with decent margins, such as clothing, are down sharply – by as much three-quarters at one stage.

But products such as toys, which are less profitable, have sold well.

Financial services

Both Tesco and Sainsbury have banks that are heavily dependent on unsecured lending, insurance and travel money.

With economists expecting GDP to contract and unemployment to rise sharply, the outlook for bad debts has deteriorated. Tesco expects its banking unit to make a loss of up to £200 million for the full year.

Low demand for fuel

Demand for petrol and diesel has roughly halved. Although these sales generate little profit, they do provide significant working capital because drivers pay cash for fuel that is bought from suppliers on credit. The absence of that effect – plus shorter payment terms for food suppliers – means supermarkets are more likely to be drawing working capital from their lenders instead.

Online deliveries make less money

The fees supermarkets charge for online deliveries – typically between £3 and £5 – do not usually cover the costs of picking up and delivering.

Covid-19 is “moving sales out of our most profitable convenience channel and driving a huge step-up in online grocery participation, our least profitable channel”, Mr Roberts told analysts at Sainsbury on Wednesday.

Supermarkets have defrayed this to some extent with bigger average transactions and more use of click-and-collect – which does at least remove the cost of delivery – but a greater share of ecommerce in revenues still makes supermarkets less profitable.

"The rapid growth [in ecommerce] during the pandemic was dilutive in the short term," acknowledged Tesco chief Dave Lewis.

Benefits of higher spend are shared

Convenience has been an important element of consumer behaviour in lockdown.

People have shopped closer to home, so chains with large local presences have done well.

Kantar estimated that in the 12 weeks to June 14th, sales at independent grocers and groups such as Premier, Nisa and Costcutter were up almost 70 per cent year on year. Co-op and Iceland have also increased their market share.

Caution around changes

Sainsbury has already changed its chief executive, with Mike Coupe handing over to Mr Roberts last month. Mr Lewis will leave Tesco in September, with Walgreens Boots executive Ken Murphy replacing him.

It is safer for retailers to under-promise early in the year and leave a new boss to take any credit for upgrades.

“No one in their right mind is going to raise guidance at the end of the first quarter, given the uncertainties we’re facing,” said Mr Black.

He added that while an economic downturn would usually make shoppers more value-conscious, supermarkets were likely to be planning price cuts over the summer to ensure they remained competitive.

Hard discounters grabbed market share from “complacent” supermarkets after the financial crisis, he said. “But they’re not going to get a second round.”– Copyright The Financial Times Limited 2020