Metro’s (= from -) emerging self-help and DIA’s (+ from =) greater margin resilience mean we raise each rating one notch. Fundamentally, we back the capital-light, proximity-discount formats (Jeronimo and DIA). UK brick & mortar grocery is considered ‘no-go’ – we sympathise, and expect little respite over Christmas, but think modest margin cuts and capex reduction in 2014 will improve the UK grocers’ relative appeal. They represent the ‘contrarian trade’, we play it through Tesco (+).
* UK margins will be pressured but capex cuts to offset
We expect Tesco will break from its 5.2% margin ‘guidance’ at its FY results in April, investing more in food, partially recouping the monies from an improved non-food offer. It will be about improving price perception and trust, not collapsing the industry P/L, but will be sufficient to take several tens of bp from quoted UK grocers’ margins. In compensation, we expect a lessening in space addition. Again we expect Tesco will lead, further curtailing its capex, with Morison following. With margin concerns already priced-in, greater capital discipline would be taken well.
* Continental grocers upping capex, often from a leveraged position
In contrast to the UK, the continental grocers need to spend more, having underinvested in the store fabric, expansion and multi-channel. The issue is that some operators’ balance sheets remain somewhat constrained against an industry backdrop where leverage needs to reduce in a low growth, multi-channel world.
* Minority listings and capital raises in vogue – who else may raise funds?
One solution to fill the funding gap, and demonstrate value is to sell minority stakes or raise new money. Carrefour has already flagged it will do so in Brazil and China, and Metro will do likewise in Russia. With these deals arguably ‘priced-in’, the question is who else will raise funds? Casino needs to delever and could sell cDiscount or its Thai business. Tesco needs to cut its international exposure to focus on fixing the UK.
* Greater need for differentiation and customer insight in a multi-channel world
Winning retailers increasingly will have ‘capital-light, P/L heavy’ propositions and ‘big data’ insights to personalise offerings and give consistent service across all shopping channels. ‘Bricks’ still matter but trust is increasingly key for a demanding consumer.
* Low food CPI should help gross margins, unless competition rises…France?
Food CPI will be low in H1 2014. That may ease ‘wage-squeeze’ but likely means a relatively soft top-line for the grocers. Gross margins should benefit unless competitive tension is elevated. The UK is ‘priced’ for this. France could be tougher as Leclerc responds to a recovering Carrefour. A recovering macro eases US tensions.
* Buy JMT, Ahold, DIA, Tesco, Casino…avoid Delhaize, Booker, Colruyt
Jeronimo and DIA sport the best capital-light models and Ahold best balances capital discipline and growth whilst evolving an on-line offering. We re-iterate our O/P ratings on JMT and Ahold and raise DIA to O/P, better recognising the potency of its franchise model. Tesco faces challenges but the shares know it. We think margins will erode less than feared, capex will come down and international assets will be sold – reiterate O/P.
* In contrast, Delhaize will need another big margin reset, and Colruyt and Booker are
just too expensive. Metro’s formats remain constrained but emerging self-help means we raise our rating to Neutral. We think competition in France will be tougher in 2014, keeping us Neutral on the well-travelled Carrefour equity. EM exposure and scope to deleverage keeps our interest in Casino.