1.  Sector Landscape and Outlook
 

Restaurants, pubs, apparel high streets in the UK are shutting down to hold up the spread of the deadly coronavirus. Thankfully, supermarkets and grocery & food retailing have defied the trends to some extent.

In the UK, the COVID-19 cases increased exponentially from 9 on 15 February 2020 to 5,683 cases as on 22 March 2020. And, the death toll in the UK has now spiked to 281 from 1 case reported on 5^th March 2020. The exponential spread of the deadly virus has sent fear and left people, state, and corporates high and dry. The UK government is leaving no stone unturned to contain the spread of this novel virus even as the cases are edging up.

The severe situation has led people to rush for their grocery shopping, and people are buying food products in higher quantity to stockpile goods in case situation deteriorates further.

This has led to a spike in demand for food retailer offerings and for those who supply value-added products to the UK food retailers and food product services. We are bullish on the UK’s packaged food distribution and food retailing businesses for FY21 and expect volume, sales, margin and profitability to increase significantly in the near term.


Demand spurt to drive sales in Q1FY21E and Q2FY21E:  The unprecedented demand spurt for food and beverages products in the wake of COVID-19 spillover is expected to boost top-line for food retailers in Q1FY21E and Q2FY21E. According to several media reports, demand for grocery products has been more than doubled as tensed British shoppers are hoarding goods. Households began stockpiling of food items since the last week of February 2020, particularly demand for pasta, packed meat, tinned soups and beverages have surged in Great Britain by more than 60% compared to the same period of corresponding financial year. Further, sales of ready meals, milk, meat, fruits, juice and bread have also seen significant increase at the food retail stores. 

Fig. 3. Increase in weekly sales of the top five food products (%)



 
Higher demand is expected to help food retailing and beverages companies to achieve economies of scale and margin expansion in FY21E: As demand spikes for a sector's offerings, it provides headroom for sector players to scale up production and increase inventories to fill the demand-supply gap. The average cost of making each unit then falls and profits rise. We also believe that a sudden demand spike will help food retailers to record a lower double digit increases in EBITDA, and PAT margin for FY21E. Also, online ordering has significantly shot up amid the challenging time; people are avoiding stepping out of their home, resulting in a sudden spike in online order, which is carrying the potential to offset the lower footfalls at the store. Further, a lower footfall in the stores will provide headroom for cost-cutting, i.e. variable costs like electricity, and contract staffs, which will further support in margin expansion.

What makes these food retailers attractive to the investors apart from the demand supply dynamics? Let’s find out.

Higher Free Cash Flow Yield implies greater safety to shareholders: Free Cash Flow Yield (%) is an essential measure of investibility in any company. Higher yield implies higher surplus or discretionary cash that a company generates from its operations for the shareholders; however, a steep fall in stock price could also increase free cash flow yields of the business, which is misleading.

Moreover, despite a massive plunge in the FTSE 100 index over the past couple of weeks, the average Free Cash Flow Yield of the FTSE 100 constituents’ stocks stood at ~ 7%, and most of it is attributed to the sharp plunge in stock prices. In contrast, the average Free Cash Flow Yield of the companies under coverage stood at ~ 8.6%.   Free Cash Flow yield is a measure of financial performance, derived from the company's cash flow from operations, minus capital expenditures and divided by the company's market capitalisation. Typically, a higher free cash flow yield is more attractive.

Offering lucrative dividend income opportunities: Amid lower interest rate regime, with yields on government securities at multi-year lows, stocks with higher dividend yield will be back in the limelight. Central banks across the globe have slashed interest rates on government bonds to provide adequate liquidity in the market; therefore, one can't find adequate interest yield when there is so much liquidity from central banks. Companies under consideration in this report are offering a decent dividend with an average dividend yield of 4%. Interestingly, all of them have a historical track record of dividend pay-out regardless of the market conditions.  UK's 10-year bond yield stands at 0.52%, which implies that the average dividend yield of food retail and beverages companies under our consideration is approximately 8 times of the 10-year UK government bond yield. However, the benchmark index dividend yield stood at about 6.8%, driven by the steep plunge in the index amid COVID-19 pandemic.

Let’s take a look at the sector’s performance in the midst of the market crash.

Relatively outperformed the broader trend amid market crash: Food retailing and beverages companies have significantly outperformed the broader trend amid free fall in the market. On an average, the relative outperformance of four companies under consideration (Tesco Plc, WM Morrison, J Sainsbury Plc, and Cranswick Plc) stood at around 29.0% in the past 4-weeks and around 28% in the past 13-weeks, which is a positive indicator and implies that, the sudden rush for their offerings is restricting the downside movement in stock prices. On a YTD basis, the average fall in the aforementioned companies stood at ~ 14%. In contrast, broader indices have tumbled more than 31% in the same period, which implies a relative average outperformance of 17% between companies under review vs benchmark FTSE 100 index.

Fig 4: Relative Price Performance vs FTSE 100


  
 
II. Investment Theme and Stocks under Discussion (SBRY, TSCO, CWK, MRW)

After gauging through the key trends, driver and stance, let’s take a detailed view of the companies in the Food Retailing sector in terms of their performance and outlook. To assess the same, companies’ stocks are evaluated based on Discounted Cash Flow (DCF).

Fig 5: Relative performance of the stocks under discussion in last 1 year (Indexed to 100)