UK Supermarket shares: Is inflation good news?

The Chancellor's measures might have put a few pence back in pockets taken away by inflation but consumers will still need to divert more spending towards the essential goods, possibly to the benefit of UK supermarkets shares.

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Spending on essentials

Traditionally, supermarkets tend to do well during periods of inflation. There are several reasons, but one of the chief ones is that cutting back on food is often the last option for consumers. So, even if people’s disposable income is eroded when wages don't keep up with price increases, consumers are likely to cut back on other retail goods in order to have enough funds for their grocery shopping.

The main issue for supermarkets is being able to pass on the increased cost of the merchandise. In the current environment, large supermarkets like Tesco, Morrisons and Sainsbury's have something of an advantage because of the pandemic. Smaller competitors were forced out of the market due to lockdowns, meaning that alternatives are harder to come by. That makes it easier for supermarkets to pass costs on, and mitigate some of the threat from budget competition such as Aldi and Lidl.

Inflation for the discounters

One of the key factors driving prices higher are logistics, but that could be a disadvantage for bargain stores like Lidl and Aldi. Their model of economies of scale and centralized sourcing could lead to higher prices since their products have to be transported longer distances. Higher inflation in the UK than elsewhere in Europe could weaken the pound in respect to the Euro, meaning that imported goods would have more price pressure than domestically-sourced ones.

Price-centred supermarkets with diversified logistics such as Tesco might perform better than quality-oriented firms like Waitrose. Supermarkets with a larger proportion of operating income coming from groceries, like Sainsbury's, might be better positioned than broader retail stores such as Marks and Spencer.

SBRY shares

Tesco and Sainsbury’s both worth 300p on January 28. Since then, TSCO lost 13% by its March 7 bottom, whereas SBRY 21% on the same day. 

Bigger picture, SBRY is still underneath a 10-year old downtrend line - meaning the long term trend is down. The shares have been pulling back from the rally off the 2020 low after a failed break of this long term downtrend line. The pullback has found support at old resistance from the late 2019 peak. If this level holds, there is scope for another test of the downtrend line and a possible long term breakout into a new uptrend.

Source: SpreadEx

Key takeaways

The UK's largest domestic supermarket chains are expected to do well during the current inflationary period as smaller competitors were forced out during covid. Investors should concern themselves primarily with retail food inflation as price increases there would have a more negative impact on Tesco than Sainsbury's.