UK retail: Foodstores – a feeding frenzy

Written By:

Stephen Springham, Knight Frank

01 Dec 2023

6 minutes to read

Categories: Property Sector Retail World Regions UK London

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Key Messages

• A compelling investment case for UK foodstores
• Extremely strong fundamentals
• Underpinned by essentially inelastic consumer demand
• High resilience to macro-economic and social pressures
• Without exception, all supermarkets are very strong, competitive operators
• Very few foodstore closures – mindset of fix rather forego
• Online compliant, rather than at risk
• Higher than average income returns in a period of uncertainty
• But now a very in-demand property class, with competitive bidding
• But foodstore assets are far from equal – stock selection is crucial
• Asset specifics absolutely paramount
• Trading performance the holy grail
• Offset trading performance vs. rent
• Catchment and competition key secondary considerations
• Geography, catchment affluence and asset presentation can be red herrings.

Form is temporary, class is permanent

Renewed recognition of foodstores amongst the property investment community is one of the few positive legacies of COVID. That it took a global pandemic to reinforce the grocery sector’s resilience and strong investment criteria beggars belief. But general scepticism is increasingly giving way to positive sentiment.

As well it might. A sector with rock solid fundamentals, albeit brutally competitive and awash with complexities. A blueprint for all real estate investment markets even, with a very clear food chain (pun intended), where all protagonists know their rightful place? And, dare I say, where property investors are fairly low down?

The UK foodstore market is defined by its occupational base – as indeed all real estate investment markets should be. The competitor set that constitute the UK grocery market are, without exception, excellent operators. Indeed, so concentrated and competitive is the UK supermarket sector that there is no ‘dead wood’ and any operational or strategic shortcomings will be quickly and cruelly exposed.
Despite some changes in capital structure (and PE rearing its ugly head), investors can be confident they are investing in real estate that is being run by operators that know what they are doing – and are here for the duration.

Nor are said operators under any illusion that they are at the top of the food chain. That position is occupied by the consumer – the consumer will always be king and the supermarkets remain subordinate to their every whim. Consumer trends and tastes may chop and change at a rapid rate, but underlying consumer demand is essentially inelastic and far less volatile than in other retail sectors. We may have more or less money at our disposal, we may trade up or down, or switch between the plethora of channels at our disposal. But we all still need to eat.

Don’t just take Knight Frank’s word for it. Our report features interviews with two key stakeholders in the foodstore market, from both sides of the occupier : investor fence - Patrick Dunne, Group Property Director at Sainsbury’s and Rob Abraham, MD of Fund Management at Supermarket Income REIT. The former providing fascinating insights from the coalface of grocery retailing from the UK’s second largest retailer, the latter equally enlightening sapience from the largest investor in UK foodstore real estate.

A word of caution: for all the foodstore market’s generic positives, asset specifics are absolutely paramount. Understanding trading performance is the holy grail, assessing catchment and competition are key secondary considerations. Conversely, geography, affluence and asset presentation could be red herrings or, worse still, false friends in any appraisal process.
A strong investment case – but not all foodstores are created equal.

5 Central Themes – Key Takeaways

1. Consumerism at its most fundamental

• The foodstore market is underscored by largely inelastic consumer demand, rendering it much more resilient than other segments of retail.
• Grocery sales have a strong track record of growth (long term average of +4.1%), with only a couple of highly challenged years (notably 2015/16).
• Grocery spend likely to grow by ca. +8% in 2023, but fuelled largely by double-digit inflation. High inflation very challenging, but less damaging than deflation.
• Inflation is slowly receding and in Q4 2023, there are welcome signs of a return to positive volume growth.
• Grocery spend likely to revert to an annual average run rate of growth of 3.0% - 3.5% from 2023.
• Given levels of competition in the market and low industry margins, any accusations of “greedflation” are very wide of the mark.

2. Changing channels

• The foodstore market comprises a wide range of formats and channels. These are at varying stages of maturity and are poised to experience contrasting rates of growth.
• Discounters remain the highest growth channel (+23.9% 2022-27f). This reflects ongoing aggressive expansion from Aldi and Lidl, despite growing concerns over potential cannibalisation.
• C-stores (+12.9% 2022-27f) are poised to be the third fastest growing channel (behind Discounters and Online). The channel is receiving fresh impetus from Asda and Morrison’s both making a more concerted play for the convenience market.
• Growth in big box foodstores will be far more pedestrian (Supermarkets +6.3%, Superstores +7.4% 2022-27f) reflecting a very constrained development pipeline for larger stores.
• Although lower growth, big boxes remain the dominant force in UK grocery, generating 50% of sales and ca. 80%+ of profits. What top-line growth they do achieve will be like-for-like and will readily filter through to the bottom line.

3. Online grocery – fad or future?

• Online grocery: growth stalling prior to COVID, massive but artificial demand spike during the pandemic itself, huge switch back to stores post COVID.
• Online grocery penetration stabilising at ca. 8-9%, likely to remain <10% for many years to come.
• But significant seasonal demand spikes, especially around Christmas (and to a certain degree other public holidays).
• Physical stores are a core component of the online market – ca. 71% of online grocery is serviced through stores, through store-pick models.
• Profitability of online grocery remains unproven – but major strategic shifts amongst operators to improve efficiencies and cost-effectiveness.
• Q-commerce to remain a niche and regional segment of the market (just 0.6% of online grocery sales and 0.07% of all grocery sales).

4. Key Players – KPIs, currencies & covenants

• No dead wood – the UK grocery market is fiercely competitive and highly concentrated – the Big Four have a combined market share of 64%.
• The capital structure of large proportion of the market has recently changed through deals involving Morrison’s and Asda – and there is much more exposure to debt.
• This has prompted a downgrade to Morrison’s credit rating and its foodstores now carry a ca. +150bps discount to other operators’ (as do Asda’s).
• Question marks over covenant continue to override other inherent strengths of the business – neither Morrison’s nor Asda has become a ‘bad retailer’ overnight.
• The discounters (Aldi and Lidl) continue to grow market share at the fastest rate. However, their already wafer thin margins are under intense pressure in a cost-inflationary market.
• Sales densities remain a key operating KPI and the ‘rule of thumb’ industry benchmark is ca. £1,000/sq ft. Understanding sales density is fundamental to any asset appraisal process.

5. The investment case

• As a resilient, defensive asset class promising long and secure income, there has been a resurgence in investor demand for foodstores.
• Recent underperformance belies a strong historic track record (annualised total return of 10.0% since 1981 vs. 8.3% for all property).
• Forecast annual total returns of 7.3% and income returns of 5.1% between 2024 and 2027 compare favourably with other use classes.
• 2023 investment volumes likely to be largely in line with 5-year (£1.7bn) and 10-year (£1.8bn) averages, a significant improvement on 2022 (£971m).
• Foodstore yields corrected swiftly over the last year and have already stabilised. At 5.00% (for prime assets subject to RPI), yields are competitive compared to other retail property use classes.

Click here to access the full report, including the two interviews with Patrick Dunne of Sainsbury’s and Rob Abraham of Supermarket Income REIT.