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Panic buying doesn’t make the supermarkets a good investment, warn managers

21 April 2020

One trading platform saw Tesco leap from 400th to 16th on its list of most bought stocks in March, but fund managers are warning that higher sales do not always equate to higher profits.

By Anthony Luzio,

Editor, Trustnet Magazine

Retail investors who bought supermarket shares in a bid to profit from the panic-buying at the start of the UK’s coronavirus outbreak have been warned that long queues at the checkouts will not necessarily translate into outsized returns.

Supermarket shares sold off as the market collapsed in March, but have rebounded to a certain extent since then as fundamentals have taken over from sentiment – the sector is likely to be one of the few beneficiaries of the economic lockdown.

Steven Noble, adviser to Supermarket Income REIT, which owns properties leased to Tesco, Sainsbury’s and Morrisons, noted that UK consumers spent an extra £1.9bn in supermarkets in March, leading to a like-for-like sales increase of 20.6 per cent, the highest sales growth ever recorded.

Performance of equities in 2020

Source: FE Analytics

“Whilst much of this was initial stockpiling, we expect quarterly like-for-like sales will continue to grow as consumers shift spending from pubs and restaurants and switch to staycations which will impact on sales of general merchandise and clothing,” he said.

The visible spike in footfall has led many retail investors to pile into supermarkets, with trading platform eToro noting that Tesco leapt to 16th place on its list of most bought stocks in March, up from 400th a month earlier.

However, investment trust managers have warned it is not this simple.

“The Covid-19 crisis caused customers to stockpile essential items and Tesco, along with the other supermarkets, saw a boost to sales volume,” said Alasdair McKinnon (pictured), who owns Tesco in the Scottish Investment Trust.

“[But] the lockdown restrictions have led to higher costs, particularly staffing costs, and the increased sales have tended to be concentrated in categories that attract a lower margin, as chilled and other short shelf-life items have been less popular.”

It is a similar story at Morrisons, a stock James de Uphaugh owns in the Edinburgh Investment Trust. He said that demand has certainly increased: before the lockdown, out-of-home meals accounted for about 25 per cent of total UK calorie consumption. This has now switched back into the home, primarily bought from the major supermarkets. 

For Morrisons, this meant an initial sales peak followed by a fall-off, but with sales still running above prior-year levels. Yet De Uphaugh said the effect on profitability is more nuanced.

“To deliver the step-up in sales and make the shopping environment safe, Morrisons has put significant cost into remodelling its stores as well as rightly increasing colleague bonuses for this year,” he explained.

“Combined with markedly lower petrol volumes, much of the benefit of extra grocery sales and the business rates relief will therefore be offset by increased operating costs and community contributions to food banks; the latter reflects Morrisons’ deep sense of responsible capitalism.

“Profitability will likely be flat year-on-year and dividends only marginally higher, given the societal sensitivity on dividend payments.”

Adam Vettese, analyst at multi-asset investment platform eToro, echoed this point.

“While it would be easy to assume supermarkets were cashing in, the reality is very different,” he said.

“Supermarkets face increased staff, distribution and store expenses during this time. That could end up costing Tesco alone nearly £1bn, despite the business rates relief the government has introduced.

“For investors, this is a classic lesson in due diligence: just because the stores are full doesn’t mean everything is rosy behind the scenes.”

Yet while fund managers and analysts warn that the panic buying will not necessarily translate into outsized returns, many still believe UK supermarkets can be decent investments for anyone willing to take a long-term view.

Gervais Williams (pictured), who runs the Diverse Income Trust, said he doesn’t expect portfolio holding Sainsbury’s to shoot the lights out, but the fact it is growing at all and there are no question marks over its survival sets it apart from a large swathe of the UK market at the moment.

“In contrast to many others, Sainsbury’s is also expected to sustain its dividend, so that our ultimate clients, those that are in retirement or working at charitable foundations, won’t be forced to go hungry through this unsettled period,” he added.

De Uphaugh said that the coronavirus pandemic may ultimately benefit the supermarkets from a long-term structural perspective, as it has already led to a reassessment of the role the grocery industry plays in society.

In addition he said that when it comes to ESG (environmental, social & governance) issues, the crisis has separated the wheat from the chaff and the supermarkets have by and large excelled from this perspective.

“A perusal of Morrisons’ past annual reports demonstrates that the company has long been a standard bearer of responsible capitalism, but events like Covid-19 really hit home that no company can make profits in a vacuum and that they need to work for all stakeholders,” he explained.

It is a similar story at Tesco, according to McKinnon, which he said has “behaved in an exemplary manner during the past few weeks”.

“It is everything you would want to see from a good corporate citizen,” he added. “These extraordinary times have demonstrated the critical nature of the UK’s food distribution network. Tesco’s decision to increase its dividend reflects the operational turnaround it has achieved in recent years and really predates the outbreak of the pandemic.”

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