Who would have thought ahead of this terrible pandemic that as a result of structural adjustments to the grocery trade, UK supermarket impairments would be written back to the tune of a quarter of a billion pounds in the case of Morrisons and Tesco UK alone?
But that is the outcome of the tumultuous times, the writebacks reflecting the material improvement in sales and cashflows per square foot witnessed by the superstore operators since the start of the pandemic in March 2020.
Most notably, the leap in supermarket revenues is a manifestation of the structural shift to online grocery shopping, which Tesco UK reported at around 18% participation as it exited the 2021 financial year, about 10 percentage points up year on year.
It is perhaps worthwhile reflecting on the massive asset writedowns that the industry endured in the past decade and the structural changes that are the runway to the current writeback activities.
British supermarkets collectively were a commercial car crash as the UK exited the financial crisis. Bloated head offices planning to open lots of space were blind to evolving shopper behaviour, most notably the need to spend less on groceries, the preference for more refined choice, greater basket rather than trolley shops and the switch to online.
The outcome of this blindness was the collapse of earnings and capital returns, cuts in shareholder benefits such as dividends, wholesale senior management change and the aforementioned asset impairments.
New managements have created better commercial conditions that have been the precursor to the asset impairment writebacks; Messrs Burnley, Coupe, Lewis and Potts bringing capital discipline to the fore, alongside steps to reduce central overheads and to create the resource pool to invest in the prices that matter in the face of the commercial challenge from German limited assortment discounters in particular.
Those new strategies meant that for much of the 2015-20 period, the market grew in value ahead of new capacity. Any industry where capacity builds slower than demand tends to witness improved economics and so it was for British supermarkets; sales densities rebuilt, balance sheet solvency ratios improved, earnings rebounded and free cashflow became positive.
Rise in online demand
All of which brings us to February 2020 and the commencement of the pandemic. One of the first behavioural outcomes of the pandemic was the stripping of supermarket shelves, leading to the temporary introduction of rationing, but also a steep rise in online grocery demand. Participation at the start of the pandemic was under 8%; we then forecast that by 2025 such participation would be around 13%.
I went to the launch of Tesco.com by Tim Mason at the Café Royal on Regent Street in 1998, and it took 23 years for industry online participation to reach around 7.5%. In 23 weeks of 2020, that doubled and NielsenIQ currently measures around 15% activity. Online grocery orders reflected the needs of those who did not wish to queue for their foodstuffs, alongside a newly digitised ‘worried well’, the vulnerable and the shielding.
With flexiblilty, unlike the fixed nature of Ocado’s centralised fulfilment model, the supermarkets rose to the online demand challenge and all but doubled channel sales through the year. Large baskets, no checking out, improved picking capabilities, higher drop densities and a step up in click & collect also drove margins in the online grocery channel, and so profitability; there were notable share gains too, as the discounters struggled online.
Accordingly, when it came to tot up the numbers, Morrisons announced a £76m impairment writeback for the 2021 financial year, followed by Tesco with £156m; I believe Sainsbury’s too should follow suit.
The pandemic will leave long shadows, not least of which in grocery is the online shift. We do not see participation falling back to single-digit levels and with further work, the medium-term outlook for British supermarkets, noting this year’s tough sales comparatives (but not cash, costs or mix), looks quite bright. Asset writebacks underscore this view.
Dr Clive Black is head of research at Shore Capital Markets
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