Supermarkets are an essential part of daily life. Who among us can manage without bread, milk, eggs, and the occasional packet of jam doughnuts?
Based on this, you might think UK supermarket stocks are a safe buy for your SIPP or your stocks and shares ISA – but the reality is more complex than it first seems.
Our demand for basic food items is relatively inelastic, but that doesn’t mean supermarkets can sit back and rake in the profits. While prices have risen dramatically in recent years thanks to high inflation, a 2023 inquiry into profiteering accusations revealed supermarkets haven’t been stoking the fire in the manner originally suggested.
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The truth is that they operate on tight margins in a fiercely competitive environment – one where they can quickly be priced out of the market if they don’t get their product prices right. This intense competition is good news for the consumer, but makes for a more volatile investment opportunity.
You only need to look at the major supermarkets’ share prices to see that it hasn’t all been smooth sailing in the post-2008 environment. That’s largely down to the entry of big discounters like Lidl and Aldi (both privately-owned), which have disrupted the traditional supermarket scene.
Against this backdrop, we look at the investment case for the three big listed UK supermarkets – Tesco, Sainsbury’s and Marks & Spencer. Should you add British supermarket stocks to your investment portfolio, or are they better avoided?
Traditional supermarkets battle Lidl and Aldi for market share
If you look at the share price history of the listed UK supermarkets, you will see that none of them have ever recovered their pre-2008 valuations. A big reason for that is the growth in popularity of Lidl and Aldi.
The German discounters first arrived in the UK in the 1990s, but have grown enormously in popularity over the past decade and a half. They now have a combined market share of 18.1%, according to data from Kantar World Panel.
This has hit Morrisons and Asda the hardest, according to Russ Mould, investment director at AJ Bell. He points out that both companies are “saddled with debt after their respective takeovers”.
Mould adds that Tesco and Sainsbury’s are holding their own when it comes to market share, but suggests this doesn’t negate the impact the German discounters have had on their margins. He says: “Their margins are not expanding and remain in the low single digits, [revealing] how competitive this business really is.”
Changing consumer habits have also created a more challenging environment for traditional supermarkets over the past decade. The UK has seen a shift away from the big weekly shop, as households instead opt for shopping little and often.
This change in behaviour means consumers are more likely to visit several stores over the course of a week, shopping around for their favourite products and the best deals. The cost-of-living crisis has only accelerated this trend, as highlighted by a recent research report from the House of Commons Library.
The report writes that “46% of adults in Great Britain reported an increase in their cost of living in March 2024 compared to a month earlier”, with 89% pointing to increased food prices as the main reason for this. It adds that 49% were shopping around more as a result, while 38% were spending less on food shopping and essentials.
While inflation has now returned to 2%, prices remain high and households are still battling higher rents and mortgage repayments. The cost-of-living crisis is far from over, and the trend of shopping around is likely to stay.
Have UK supermarket stocks delivered decent investor returns?
Nevertheless, it isn’t all bad news. We’re now just over halfway through the year, and Tesco and Marks & Spencer have posted decent returns so far in 2024.
Both stocks are up by around 5% year-to-date, broadly in line with the overall FTSE 100. Tesco paid a full-year dividend of 12.10p (a yield of 3.93%). Meanwhile, Marks & Spencer’s 3p dividend represents a yield of 1.03%.
There are other sectors in the FTSE that are offering higher returns – see our piece on the best and worst performers. But if the two supermarkets achieve similar growth in the second half, it will be a pretty good year.
Sainsbury’s share price performance, on the other hand, has been pretty poor. It is down by around 14% year-to-date. The company announced a full-year dividend of 13.10p (a yield of 5.12%), but it is unlikely to be enough to entice investors given the poor share price performance. They can earn the same yield by simply putting their cash in the bank.
Chris Beckett, head of equity research at Quilter Cheviot, says the supermarket remains “considerably smaller than Tesco, and in the high-volume, low margin world of food retail, scale is a critical factor and the ingredient for success”.
Commentators also point out that Sainsbury’s non-food business (including Argos) has experienced a slowdown of late, and is letting the side down.
Mould says: “It’s beginning to have a lot of similarities to the Marks & Spencer of old, running a two-pronged business with one engine constantly spluttering. Marks & Spencer has finally fixed its engine problem and is now racing away, which might give some hope to Sainsbury’s situation.”
Indeed, Marks & Spencer fell out of favour with investors a few years ago, even dropping out of the FTSE 100 between 2019 and 2023. However, since then, the company’s management team has been on a mission to reshape the old M&S.
This seems to be working – Marks & Spencer shares recently jumped to a six-year high after it announced its results for the 2023/2024 financial year. Profits had surged almost 60% compared to the year before, with food sales up 13% and clothing and home sales up 5.3%.
“Two years into our plan to Reshape for Growth we can see the beginnings of a new M&S,” said chief executive Stuart Machin. “We are becoming more relevant, to more people, more of the time.”
If interest rates fall later this year and inflation continues to slow, supermarkets will be hoping to see shoppers putting more items in their baskets. This could create a tailwind going forward.
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