Value may be up, but volume is down. The industry would be wise to keep inflation at the forefront of their minds when forecasting.
The reporting season for the food producers has come to an end and it is clear that while overall sales growth in the industry is robust, this is purely due to inflation. Dig a little deeper and the common theme is that volume sales are negative.
Unilever even reports that promotional activity has declined in its first half (although ad spend is up). What we conclude from this is that gross margins are under pressure in the UK food retail sector. Stock-market valuations and forecasts simply do not reflect this, and we expect smiles to droop into frowns for the next six months at least as the true situation dawns on the City.
Three manufacturers of various scales and different product categories – Unilever, Danone and Northern Foods – have been singing from the same hymn sheet for the last few weeks or so. All reported that while total sales growth was at the top end of – or exceeding – their predictions, underlying this had been a negative volume performance.
Unilever reports that Europe-wide volumes were down 2.9% in its second quarter. At Danone, volumes fell 2.7%. Closer to home, Northern Foods’ volumes fell 2% in the period. It is clear to us that the consumer has simply been unable to stomach the cost increases. Something had to give, and it has.
Our recent conservations with major UK players, combined with the evidence of external statistics, suggest that inflation continues to climb. We estimate that the actual level of inflation in the UK at present is about 6%. This is still way below the speed at which factory gate prices are rising, which is to say that the retailers are taking some of the pain on the chin. Morrisons, for example, has made it clear that it is investing into margin by absorbing some of the cost increases. The widespread view in the sector that the summer’s promotional activity is nothing out of the ordinary is not destined to remain intact for long.
Our forecast is for gross margins to fall by 20 base points this year and we are mindful that this is a conservative estimate. There are material risks to forecasts. We think that we will see share prices come under pressure on the basis of lower earnings as differential inflation bites.
Our view remains that most at risk of coming a cropper in forecasting terms is Sainsbury’s, but that Morrisons is far from risk free. Tesco appears to be the best bet, albeit not a compelling one. We wait with interest to see if Cash Savers is to cross the Irish Sea...
Jonathan Pritchard is a partner at Oriel Securities
The reporting season for the food producers has come to an end and it is clear that while overall sales growth in the industry is robust, this is purely due to inflation. Dig a little deeper and the common theme is that volume sales are negative.
Unilever even reports that promotional activity has declined in its first half (although ad spend is up). What we conclude from this is that gross margins are under pressure in the UK food retail sector. Stock-market valuations and forecasts simply do not reflect this, and we expect smiles to droop into frowns for the next six months at least as the true situation dawns on the City.
Three manufacturers of various scales and different product categories – Unilever, Danone and Northern Foods – have been singing from the same hymn sheet for the last few weeks or so. All reported that while total sales growth was at the top end of – or exceeding – their predictions, underlying this had been a negative volume performance.
Unilever reports that Europe-wide volumes were down 2.9% in its second quarter. At Danone, volumes fell 2.7%. Closer to home, Northern Foods’ volumes fell 2% in the period. It is clear to us that the consumer has simply been unable to stomach the cost increases. Something had to give, and it has.
Our recent conservations with major UK players, combined with the evidence of external statistics, suggest that inflation continues to climb. We estimate that the actual level of inflation in the UK at present is about 6%. This is still way below the speed at which factory gate prices are rising, which is to say that the retailers are taking some of the pain on the chin. Morrisons, for example, has made it clear that it is investing into margin by absorbing some of the cost increases. The widespread view in the sector that the summer’s promotional activity is nothing out of the ordinary is not destined to remain intact for long.
Our forecast is for gross margins to fall by 20 base points this year and we are mindful that this is a conservative estimate. There are material risks to forecasts. We think that we will see share prices come under pressure on the basis of lower earnings as differential inflation bites.
Our view remains that most at risk of coming a cropper in forecasting terms is Sainsbury’s, but that Morrisons is far from risk free. Tesco appears to be the best bet, albeit not a compelling one. We wait with interest to see if Cash Savers is to cross the Irish Sea...
Jonathan Pritchard is a partner at Oriel Securities
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