Here's why the UK's food sector has a rocky road ahead

 
Harriet Green
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Source: Wikimedia

With some dire Christmas sales, heavy discounting and a ramping up of online shopping, the UK food retail sector feels unloved.

That’s according to Barclays, which points out that the UK’s sector is now trading at a clear price-to-earnings discount when compared with continental Europe.

It hasn’t always been like this for UK companies. Expansion was common and margins were stable or rising - even the discount segment was a place where market share gains could be made by major players.

But today, the market’s taking a negative view pretty much across the board. It seems to think that discounters and online will up their market share, but to the detriment of the incumbents’ margins. The possibility for value-creation from financial services and non-food seems all but written off.

And unfortunately, Barclays doesn’t see many flaws in this outlook. Discounters will continue storming ahead, and non-food has “switched from being a tailwind to being a headwind” - and that looks unlikely to change anytime soon.

Market leader Tesco’s international assets could, says the bank, become a profit driver again, but the market will need to see more stability before relying on it.

There are some positive angles, though. Capital expenditure cut backs and improved cash flows by UK names has seen dividend yields - collectively, that is, exceed five per cent. Enterprise values are trumped by real estate holdings, and private equity interest “cannot be ruled out”.

These elements give some downside protection - the bank believes dividend yields are fairly secure for the medium-term. It’s not sure, however, that they alone “carry sufficient weight to drive share prices higher”.

But even though outlook’s gloomy, a tough sector can get to a point where all negative issues are fully factored in, says Barclays.

Sainsbury’s continued to outpace its peers, trading on a price-to-earnings multiple of less than 10 times, with a price target of 410p. It gives Tesco a price target of 340p, and says its outlined plans for the UK give more confidence that sales lines could be reinvigorated.

But when it came to the country's number four, Morrisons, it warned that it’s struggling to "find an easy route to recovery" for stock.