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‘Supermarket giants doomed’. No, just history repeating.

A few years ago, market watchers were convinced the supermarket giants were doomed at the hands of a new breed of discounters. As is often the case, however, the reality has proved rather more nuanced than that

23/01/2018

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

For a discipline that offers few certainties, investment can attract an awful lot of, well, certainty.

Whether it be investors, analysts, journalists or other market commentators, people often become convinced some scenario or trend definitely will or will not play out.

Check back a few years later, however – always assuming it even occurs to anyone to do so – and that certainty does not always prove to have been warranted.

'Game over for supermarket giants' 

Go back three or four years, for example, and many were arguing it was ‘game over’ for supermarket giants, such as Morrisons, Sainsbury and Tesco.

The undeniable pressure being brought to bear by the so-called ‘hard discounters’ of Aldi and Lidl led market watchers to conclude there was nothing the incumbent players could do to stop them. As is often the case, the reality has proved rather more nuanced than that.

What led to people writing off Tesco and the others was people extrapolating the present – in this case, the huge growth of Aldi and Lidl at the time – onwards into the future.

Fast-forward to today, however, and while these ‘low-cost airlines of food retail’ have demonstrably continued to build their market share, the strong financial performance that was supposed to have accompanied that growth has been less obvious.

To illustrate the point, we will focus on the performance of Aldi over the last decade or so.

As you can see from the following charts, while the business has seen its turnover continue to grow at an impressive rate (Chart 1), its profits have tailed off noticeably in recent years (Chart 2). 

 Chart 1: Aldi Turnover

Source: Companies House via Barclays

 

Chart 2: Aldi Operating Profit

Source: Companies House via Barclays

 

What that has meant is its margins have also started to come down (Chart 3).

 

Chart 3: Aldi Operating Margin

 Source: Companies House via Barclays

 

This is significant because the principal argument in favour of the discounters was that their ability to buy products cheaper overseas gave them a big margin advantage and thus a competitive edge over the incumbent supermarkets.

In reality, however, this margin has been eroded, with the result that Aldi’s return on capital employed (RoIC)– that is, its return on the assets it is allocating to the UK – is also falling (Chart 4).

 

Chart 4: Aldi Return on Invested Capital (pre-tax)

 Source: Companies House via Barclays

 

Towards the end of 2016, Aldi UK even announced it would be spending some £300m revamping its stores that, if it follows the pattern of a similar project in the US, will see its no-frills, ‘pile high, sell cheap’ approach to the customer experience replaced with the softer lighting and wider aisles one might usually associate with, well, a Morrisons, Sainsbury or Tesco.

So what everybody thought they knew for certain a few years back has not materialised and a very different picture has emerged.

Not that you are likely to read that in very many places, of course – for one thing, people are understandably disinclined to look back and flag up the fact they were wrong and, for another, plucky start-ups eating (or in this case selling) incumbent giants’ lunch remains a popular narrative.

We've been here before

As it happens, we actually wrote about all this back in 2014, here on The Value Perspective. In Price war déjà vu, we discussed the threat Aldi and Lidl were posing to the giants of food retail and how this mirrored a similar period in the early 1990s when markets commentators were convinced Sainsbury, Tesco and the rest were doomed at the hands of the previous generation of discounters, such as Gateway and Iceland.

For reasons that will soon become apparent, it seems appropriate to reprise that piece’s final paragraph:

“Dame Shirley Bassey may well have said it best …

The word is about, there’s something evolving, whatever may come, the world keeps revolving, they say the next big thing is here, that the revolution’s near, but to me it seems quite clear, that it’s all just a little bit of history repeating."

Author

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

I joined Schroders in 2015 as a member of the Value Investment team. Prior to joining Schroders I was responsible for the UK research process at Threadneedle. I began my investment career in 2001 at Dresdner Kleinwort as a Pan-European transport analyst. 

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