Food inflation to benefit UK supermarkets

UPWARD pressures on food prices appear to be here to stay. Global demand is increasing while droughts and fires last month hit harvests in Russia and Ukraine. Market researcher Kantar Worldpanel anticipates that UK grocery inflation will rise to an annualised 4 per cent by the end of 2010 from its current rate of 2 per cent.

Upward pressures are already feeding through to prices. Data from the UN Food and Agriculture Organisation (FAO) showed that global meat prices rose in August to their highest level since 1990. Lamb prices rose to a 37-year high while beef is at its most expensive in two years. The UK’s Office for National Statistics says fruit prices have risen by 10 per cent in the last year while fish is up 8 per cent.

Consequently, contracts for difference (CFD) traders might be bullish about the prospects for the UK food retail sector. An environment of rising grocery prices should help investor sentiment towards the sector recover, says Sam Hart, retail analyst at stockbrokers Charles Stanley. “We expect sentiment to gradually improve as food price inflation returns (driven by higher wheat prices) and like-for-like sales growth accelerates,” he explains.

Arden International’s Nick Bubb agrees: “The food retailers have begun to pick up [share price] support on the view that food price inflation (and therefore like-for-like sales) should edge up through the second half from its very low level in the spring.”

Unlike non-food retailers, analysts expect grocery firms – or those that derive the majority of their business from food – to remain resilient and better able to maintain profitability thanks to the essential nature of food spending.

This should prove easier for UK supermarkets such as Tesco, J Sainsbury and WM Morrisons than their European rivals, which face aggressive competition from the hard discounters. For example, Dutch Ahold and French Carrefour and Casino will struggle to pass on commodity price inflation to the consumer when the likes of Aldi and Lidl are nipping at their heels.

But while traders might be more upbeat about UK food retailers’ prospects, the sector is forecast to face headwinds in the fourth quarter of the year and beyond. S&P Equity Research’s James Monro argues that as we return to an inflationary cycle, inflation is now the proverbial cross for food retailers to bear, with consumers remaining sensitive to price. “Following long periods of discounting and promotions, it would be virtually impossible for retailers to raise prices, unless the sector moves prices en masse,” he says.

The pick of the UK grocers remains Morrisons, which reports interim results on Thursday. Arden International’s Bubb says: “The buzz about higher price inflation in the pipeline for the industry looks timely for the long-awaited debut of the new Irish chief executive Dalton Phillips. I think that will be the catalyst for an overdue re-rating and still target 345p.” Morrisons is trading at just below 290p. This upside would make the firm an ideal buy for a CFD trader with a medium-term view. In contrast, Sainsbury’s has seen strong stock performance compared to its peers such that it now looks over-valued.

Overall, traders should favour UK grocers to their European counterparts and be ready to select specific stocks given the mixed fortunes of the sector as a whole.