CD&R’s £5.5bn offer for Morrisons has created a great deal of conversation across the grocery sector. Supermarket C-suites will be watching closely as the story develops. Coming relatively hot on the heels of the TDR/ Issa brothers’ acquisition of Asda, it seems the grocery sector is back in favour with PE, and understandably so…
As crises go, the supermarkets largely navigated the pandemic well. Initial glitches in stock and delivery slots were ironed out quickly and the reputation of the nation’s grocers was at an all-time high as they were truly regarded as an essential service. People will always need to eat, so supermarkets, among other similarly secure sectors, are probably looking like an attractive investment right now.
However, there are complexities in the sector and there is still a lot of uncertainty post-pandemic that presents some challenges in the grocery market. PE investors will need to tread carefully and draw heavily on their transformation experience to prosper. Grocery is a sector with notoriously narrow margins. While the increasing shift to online finds favour with consumers, it is dilutive to profits. Fulfilment is more expensive and complex and serving rural communities is more or less universally loss-making. Although consumer priorities and shopping habits have changed as a result of COVID-19, the extent to which these changes are permanent remains to be seen. There is a tipping point in online sales at which the investment needed makes sense and without it the investment is just not worth it.
The other issue is that buy and build strategies may be off the table for some time. The CMA has shown a resistance to consolidation in the grocery sector lately and there is no sense that this will change any time soon. Partnerships and alliances may help to navigate some of the investment challenges but, as we have seen elsewhere in the sector, these can shift dramatically and do not necessarily provide a solid foundation for large scale investment.
So, while grocery has its attractions, it is still part of one of the most disrupted industries in the world today. Much of retail continues to face significant disruptive challenges and grocery is no exception. If the increased revenues of the last 15 months begin to flatten as consumers enjoy their newly rediscovered freedoms and spend elsewhere, then the transformation requirements and associated level of investment may become overwhelming. While PE may be well positioned to drive forward dramatic change away from the near-term expectations of the markets, grocery will continue to be a challenging sector with small margins and a huge transformation challenge ahead.