European and U.K. retailers faced a tough year in 2012, but weathered mostly stagnant growth in the fourth quarter by adopting some of their customers' strategies: They tightened their belts, focused on discounting and shed some unnecessary luxuries.
"In grocery, what we're seeing is that increases are driven by inflation," says Patrick O'Brien, lead retail analyst at London-based Verdict Research. "Consumers are spending a bit more, but buying a bit less," he says.
Verdict estimated overall household disposable income declined by 1.0 percent in 2011, a contraction that's expected to continue in 2013. "It seems unlikely that we will see substantial earnings growth until 2014," Verdict said in a forecast of fourth-quarter consumer trends.
European retailers' earnings and revenues are under pressure not just from soft economic conditions, but also from structural upheavals in the industry, said Standard & Poor's Ratings Services in a report released in November.
"Weak consumer spending, exacerbated by high unemployment and shrinking disposable incomes, is damaging retailers' top lines," said Standard & Poor's credit analyst Raam Ratnam. Retailers' profitability also is declining due to the growth of e-commerce and customers' increased acceptance of discount retailers, he said in the report. Commodity prices also are up, further pressuring profits, the rating agency says.
In response to changing consumer behavior, which includes less loyalty to particular brands and stores, European retailers are increasing consumer services and facilitating access to "mobile," or Internet-based shopping, analysts at Fitch Ratings said in an October special report. Retailers also are working more closely with international food manufacturers to spur product innovation, they said.
Given tight household budgets, shoppers hesitate to trade up and are careful not to spend more than strictly necessary, analysts say. "Shoppers have become addicted to discounting," O'Brien says. Because of recent increases in promotions, "there has not been a period without discounts," he said. "So the discount price has become the 'true' price."
A group of eight major supermarkets has agreed to adopt a set of principles written by the U.K.'s Office of Fair Trading designed to put some voluntary controls on food pricing display and promotional practices. The retailers – Tesco, Sainsbury's, Morrisons, Waitrose, Marks and Spencer, Aldi, the Co-op and Lidl – have promised to follow guidelines that seek to ensure discounts really are bargains, and that prices are not artificially inflated, then deflated.
Share figures for U.K. retailers published in December from Kantar Worldpanel for the 12 weeks ending Nov. 25, showed the grocery market grew by 3.2 percent. That gain is in line with the average over the past eight months, Kantar says, but is below the company's estimate of a 3.5 percent grocery inflation rate.
Nonetheless, "strong performances from Waitrose, Iceland, Aldi and Lidl continue to be a key feature of the [U.K.] grocery market," says Edward Garner, director at Kantar Worldpanel. Of the big four U.K. retailers – Asda, Morrisons, Sainsbury's and Tesco – Sainsbury's was the top performer in the most recent Kantar Worldpanel survey, with year-on-year growth of 4.7 percent, Garner said. "While the other big three retailers all experienced share losses, ... [Sainsbury's] has managed to lift its share from 16.7 percent last year to 16.9 percent now."
According to early-December retailer performance figures released by Nielsen, a global provider of consumer information, Tesco's growth improved in the weeks leading up to the Christmas holiday. Sales were helped by the continued use of vouchers and coupons, as well as in-store promotions.
Waitrose gained market momentum by appealing to time-strapped customers.Waitrose.com offers free London delivery service to online shoppers who spend more than 50 pounds on an order of groceries. The grocer recently advertised it had the "ultimate kitchen utensil" – a Waitrose iPhone app.
"The only real growth in volume is convenience stores and online," O'Brien says. "Aldi and discounters do well, and some up-market stores like Waitrose do well."
Aldi Turns Up the Heat
The advance of German-owned supermarket chain Aldi "continues unabated and its 27.3 percent growth is being built on a solid foundation with 10 percent more shoppers than a year ago and 17 percent growth in the value of each shopping basket," Garner says.
Aldi turned up the heat on the competition with an ambitious expansion program. The retailer also kept the focus on price discounts, analysts said. Aldi's profile rose when middle-class shoppers branching out from traditional mid-range stores embraced their bargain brands.
The German discounter intends to open another 40 stores in the U.K. in 2013 to bring its total to more than 500 outlets, Garner says. Some will be smaller stores in key shopping areas,"which will help the retailer to become more competitive in the convenience market and is likely to cement its success further," he says.
Aldi also fills the convenience-market niche on Germany. "If you stand on an urban corner [in Germany], you are almost certain to spot an Aldi's," Garner says.
In contrast with Aldi's expansion plans,Tesco is seeking to improve its image at home in the U.K., pulling back from a period of global outreach. In the second quarter of 2012, Tesco embarked on a $1.6 billion initiative to renovate its stores, add staff and freshen up its product offerings.
Despite flagging EU economies, cross-border retailer expansion continues, Jones Lang LaSalle said in a November report on global property markets. "But retailers are very selective when acquiring new stores," the report said.
The commercial real estate company said prime "high street" rents in the key European retail markets generally remained stable during the third quarter, with the highest increase recorded in Berlin, where growth was up 12.5 percent quarter-on-quarter.
A number of prime retail markets are expected to show robust rental growth in 2013, including Moscow, London, Helsinki, Hamburg and Berlin, Jones Lang LaSalle says.
But expansion is not always a recipe for success. Researchers at Fitch Ratings projected single-digit revenue growth and continued operating margin pressure for European food retailers. In their October report, Fitch analysts noted most European retailers"are revisiting their business models, store expansion and geographical diversification plans" in order to address management and shareholder concerns.
Fitch cited French-based Carrefour SA and U.K.-based Tesco PLC as having high business risks "relative to their ratings levels," amid challenges in their core French and U.K. markets.
Economic Pressures Build
FoodDrinkEurope, which represents the European food and drink industry, suggested in a December report that the European Union food industry's competitiveness was compromised by the European Union's lack of an industrial policy for the sector, "insufficient export expansion" and the absence of a true single market for food.
At the same time, competitive pressures intensified across Europe, the result of low organic revenue growth, Fitch says. Consumer confidence was hard-hit by the debt crisis in Southern Europe.
The Bundesbank, the central bank of Germany, on Dec. 7 cut its forecast for German growth in 2013 to an increase of just 0.4 percent, a sharp decline from the 1.6 percent increase the central bank projected in June. However, the bankers said the German economy is expected to rebound from its slowdown in 2014, when they forecast gross domestic product would grow by 1.9 percent.
Tesco Chief Executive Philip Clarke said in a statement on third-quarter performance that total sales in the U.K. including VAT and petrol [gasoline] grew 1.7 percent, and 2.3 percent excluding petrol.
However, Tesco's total sales in Europe for the period ended Nov. 24 saw growth of 1.1 percent at constant exchange rates, with the weakness of the European currencies against sterling impacting growth at actual rates. Like-for-like sales declined by 3.6 percent.
Emerging markets, whose faster-growing economies helped boost international retailers' bottom lines, became less of an asset as their growth rates slowed. Poland, Slovakia and the Czech Republic were particularly affected, Tesco said, the result of increasing unemployment and weakening consumer confidence.
Tesco is completing a strategic review of its Fresh & Easy chain, and its expected withdrawal from the United States would benefit Tesco's financial profile by halting several more years of operating losses, Fitch Ratings said in a comment. Expectations for growth from the U.S. business proved overly optimistic, the agency said, especially since the initiative was launched just before the economic downturn.
Digesting its U.S. division would "remove distractions" from Tesco's biggest immediate threat to the group's credit profile and rating, Fitch says. That includes "the continuing drop in like-for-like sales, market share and margin at its core U.K. business."
"They've got quite a lot on their plate," commented Verdict's O'Brien, referring to Tesco's announcement that it was re-evaluating its U.S. business.
Moderation of capital spending "could provide some relief for European retailers from a financial standpoint," said analysts at Standard & Poor's, but many in the sector are under pressure "to invest in store refurbishment, expansion and improving [their] online capacities."