Yesterday, the Office for National Statistics (ONS) released inflation data for the 12 months to the end of February. Immediately after the markets opened, most FTSE 100 stocks started to fall.
Investors don’t like surprises, and are particularly nervous about rising prices. Economists expected a figure below 10%. Instead, ONS figures showed that the annual rate of inflation had increased from 10.1% to 10.4%.
What’s the problem?
Inflation erodes the value of cash. It depresses living standards and leaves individuals with less disposable income.
No wonder Ronald Reagan, the former US President, once said: “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man“.
But despite the unexpected increase in the rate of inflation, I think there are two members of the FTSE 100 that are well positioned to overcome the challenges that this brings.
Check out these two
In January, both Tesco and J Sainsbury released trading updates.
In the 19 weeks to 7 January 2023, Tesco announced a 7.9% increase in like-for-like sales. For the 16 weeks to the same date, Sainsbury’s recorded a 5.9% rise in its turnover. Both these figures exclude the impact of fuel.
With inflation remaining high, supermarket revenues are likely to increase further. But wise old accountants know that turnover is vanity and profit is sanity. It’s the bottom line that matters.
Both supermarkets are increasing prices because they are having to pay more for the products they sell. This is best illustrated by looking at the most recent accounts of Unilever. The company sells over 400 well-known brands to retailers. In 2022, it saw a 2.1% decrease in sales volumes, yet managed to increase its prices by 11.3%.
On the up
But I think the earnings of the UK’s two largest grocers will rise.
With household incomes squeezed, shoppers are looking to cheaper brands. This is good news for Tesco and Sainsbury’s, who have numerous own-label products on sale. The profit margins on these are much higher than the items they buy from, for example, Unilever.
Most economists expect inflation to be sharply lower by the end of the year. But this means prices are still rising, albeit more slowly. I doubt we’ll ever see the cost of our groceries returning to levels seen a couple of years ago.
High prices are here to stay. But some supermarket overheads should fall.
Gas and electricity accounts for approximately 12% of a store’s operating costs. And wholesale energy prices are now retreating from their recent highs. This will soon feed through to bills and improve the earnings of supermarkets.
A combination of increased automation and efficiencies means staff costs as a proportion of revenues should continue their downward trend.
The verdict
In the face of competition from the discounters, Tesco and Sainsbury’s appear to be holding their own. The market share of both is almost identical to what it was two years ago.
Selling groceries is a tough business — every £1 of sales contributes less than 2p of profit. But, I’d be happy to include either of these stocks in my portfolio.
Unfortunately, rising inflation is putting my finances under pressure, which means I don’t have any spare cash to invest at the moment.
