Why Are UK Grocers Still Expanding in a Shrinking Market?

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1 February. 26, 2015 Why Are UK Grocers Still Expanding in a Shrinking Market? Sales in the non- discount grocery segment will contract by more than 1% this year, FBIC forecasts Any recovery by long- struggling market leader Tesco will hit other big players Major chains are continuing to add space, despite declining sales in the non- discount grocery segment. As a result, they are seeing sales densities fall year after year Adding more stores will likely devalue some retailers existing real estate, setting the scene for further property writedowns DEBORAH WEINSWIG Executive Director Head Global Retail & Technology Fung Business Intelligence Centre deborahweinswig@fung1937.com New york:

2 Why Are UK Grocers Still Expanding in a Shrinking Market? NON- DISCOUNT GROCERY SALES FORECAST TO FALL IN 2015 The old guard of the UK grocery business Tesco, Sainsbury s, Asda and Morrisons have been thrown into disarray by fast- growing German discounters Aldi and Lidl. We forecast Aldi and Lidl will collectively expand sales by almost 16% in 2015, leaving them with around 10% of the total grocery sector. And in a deflationary market, we forecast the non- discount segment of the grocery market will see sales fall by more than 1% in total in That means the major chains are fighting over a diminishing share of the pie. February 26, 2015 Figure 1. UK Grocery Sector Sales and Forecasts by Segment F 2015F Million Million Million YoY % Change Aldi and Lidl (Estimates) 8,625 10,557 12, Rest of Sector 118, , , Figures exclude VAT Source: Office for National Statistics/Company reports/fbic Global Retail & Technology forecasts The total grocery sector will see a very slight decline in sales for 2015 as a whole, we forecast. This is due to the deflationary environment, which in 2015 will be further helped by strong price competition in the sector and a strengthening of the pound against the euro. In spite of this bleak picture, long- struggling market leader Tesco finally saw sales growth turn positive in the 12 weeks prior to February 1, according to market- share monitoring service Kantar Worldpanel albeit by only 0.3%. The emergence of an improving trend in sales momentum had already been noted when Tesco turned in better- than- expected results for Christmas And given the upbeat Christmas trading statement, we think Tesco could post positive UK comps either for 4Q, which it reports on April 22, or for 1Q of the 2015 year, which it reports in June. Given the context, any recovery by Tesco this year will almost certainly be at the expense of one of its main rivals Sainsbury s, Asda or Morrisons. SO WHY ARE THE MAJOR CHAINS STILL ADDING MORE STORES In a bid to capture new sales, the UK s big grocery retailers are opening higher- growth convenience stores in city centers, suburban neighborhoods and transit locations. As a result, in the face of falling segment sales, they are counterintuitively growing their total selling space. Admittedly, the traditional grocers are also pulling back on building some new supermarkets, and some are closing handfuls of unprofitable stores: 2

3 Tesco has halted planned big- store openings and is closing a few dozen unprofitable stores Morrisons expects all future openings to be in the convenience format rather than supermarkets and it plans to close ten unprofitable stores Sainsbury s recently announced that it will cut back on new supermarket openings But total store numbers and sales areas at these chains continue to grow. Even after its recent strategic review, which prompted a scaling back of big- store openings, Sainsbury s said it would open a further 500,000 sq. ft. of space in each of the following two years, and then 350,000 sq. ft. in In total, this will add a further 6% to the company s current space, as shown below. Figure 2. Tesco and Sainsbury s Total UK Sales Areas 45,000 40,000 35,000 30,000 Tesco Sainsbury's 000 Sq. Ft. 25,000 20,000 15,000 10,000 5, estimates are data at interim results Source: Company reports (Est.) ADDING MORE SPACE WILL DRIVE DOWN SALES DENSITIES FURTHER The inevitable result has been sales densities falling year- on- year, even while Sainsbury s was posting positive comps. And this is despite these retailers pushing aggressively into the convenience format, whose typically higher sales per square foot should be providing a fillip to average densities. Given that extra space continues to be added, not just by these retailers but also by fast- expanding Aldi and Lidl, it s hard to see these trends reversing. 3

4 Figure 3. Tesco and Sainsbury s UK Sales Densities 1,200 Tesco Sainsbury's 1,150 per Sq. Ft. 1,100 1,050 1, (Est.) Sales per sq. ft. calculated on annual average sales area Source: Company reports/fbic Global Retail & Technology analysis THE CONVENIENCE STORE BOOM RISKS CANNIBALIZATION As we have already noted, the push into new space is not indiscriminate most of the big players are focusing on convenience stores. We believe a big problem for the non- discounters is that these convenience stores are likely to cannibalize sales from their own supermarkets: if a Sainsbury s Local opens closer to home, then there is less reason for a shopper to drive to the large Sainsbury s superstore. In turn, those consumer shifts are then used to justify more convenience store openings, creating a spiral of cannibalization. The dilemma for the retailers is that if they pull back on convenience store openings to temper this cannibalization, then they leave the field open for their rivals to take that space. So it looks like the top grocers are adding more space simply to stand still. FURTHER PROPERTY WRITEDOWNS LIKELY AS SALES DENSITIES FALL Given this context, it s not surprising that we ve seen writedowns on property from Tesco ( 804 million in 2013) and Sainsbury s ( 92 million in 2014), due to a mix of planned developments being cancelled and the value of some of their existing stores falling. Our conclusion: In a weak sector, continuing to add more space will drive sales densities down further, in turn devaluing retailers existing space and increasing the likelihood of further property writedowns. 4

5 Deborah Weinswig, CPA Executive Director Head Global Retail & Technology Fung Business Intelligence Centre New York: Hong Kong: Marie Driscoll, CFA Christine Haggerty John Harmon, CFA Amy Hedrick John Mercer Lan Rosengard Jing Wang 5