With the UK consumer price index falling 0.1% year-on-year in April, despite rising consumer spending and an inreased market share, supermarkets are having a harder time of it, as evidenced by Sainsbury’s announcement on 10 June that its profits have dropped for the sixth consecutive quarter.
However, Frikkee, manager of S&W’s UK Equity Income Fund, says that there are ways around it, outlining businesses with wide-ranging product lines as her preferred stocks.
“The volume of products being bought is growing as people have more disposable income due to low fuel and food prices,” she said.
“But the trend we have seen in the industry data is that, while consumers are spending more in supermarkets, the supermarkets are fighting each other and putting prices down. Food price deflation is around 2%. So even if people are spending 2% more, while supermarkets’ sales volumes are up, costs are up 2-3%, and net-net it is not beneficial for them.
“It is evidence of a strong consumer, but as an investor in the consumer goods sector you want your companies to be profitable by managing what it sells and therefore managing its costs. For example, while a business like WH Smith’s high street profits are down, in its travel business – airport bookshops etcetera – profits are up. This is a sign of either more people traveling, the same number of travellers spending more, or both – all of which points back to rising consumer spending.”
Tesco is also feeling the heat, with a £6.4bn loss in the year to 30 February announced in April – the worst results in the firm’s 96-year history.
So given the suppressive effect that prices are having on margins, should investors be targeting any of the big UK supermarkets?
Nicla Di Palma, equity analyst at Brewin Dolphin, said: “Despite the difficult market conditions, Sainsbury’s continues to invest in the areas with the highest growth potential which will contribute towards its resilience in the current trading environment.
“We do not see any change to earnings expectations of £557m in pre-tax profit, compared to £681m last year, but even at these levels Sainsbury’s profitability will be significantly better than its listed peers. The announcement by Morrisons that it will cut prices further is a marginal negative, but we continue to believe that Sainsbury is the best placed among the three listed supermarkets.”
Money in their pockets
Frikkee currently holds a 28.7% allocation to the consumer goods and services sectors, and is optimistic on the short to medium-term outlook for consumer spending.
However, she warned that while the forward view is relatively rosy, there are a number of factors that could weigh in and upset the applecart.
She expanded: “There are several risks to consumer spending: if supermarkets decide to charge more and take a market share loss, which is a very risky strategy and unlikely to happen; companies decide to cut wages, which is more of a recession scenario; and the oil price moving back up.
“The number of active rigs is an indication of oil supply – the number of active rigs in the US is down by around half since September, and, while there is a lag, it will have an impact on supply and therefore the oil price.
“But the biggest risk to the consumption story is mortgages. Though, even if interest rates were to go up – which they will, because they cannot go down any further – then there will be a delay because people are locked in for certain time periods, but we will be paying more and discretionary spending will slow.”
That said, Frikkee believes that while there could be trouble lurking on the horizon, overall the current economic environment is conducive to continued discretionary spending.
“Companies are on a gentle growth path, which is good for wages and for sentiment,” she said: “Also, there are a few factors going in the consumers’ favour – fuel, food, utilities and low interest rates. The interest rates will go up, but because the government and consumer still has a lot of debt, the government wants the economy to keep growing and a rise will be later and more gradual than many people think.”
