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2017 could be another tough year for the grocers

The big FTSE-listed UK supermarkets are all reporting this week, which means we should find out how they fared during the vital Christmas period. Even a bumper festive period won’t change the fact that 2017 looks set to be a tricky year for the sector.

Food fight

The big grocers have inflicted a decade of misery on shareholders. Exactly 10 years ago, sector giant Tesco (LSE: TSCO) traded at 500p, today you can pick up its stock for 199p, a drop of an astonishing 60% over a decade. Over the same period, J Sainsbury (LSE: SBRY) plunged 38% from 412p to 252p, while Morrisons (LSE: MRW) fell 16% from 279p to today’s 234p. Fresh and tasty they are not.

Management hubris is partly to blame, especially at corporate jet loving Tesco, whose plans for global domination ended in a fight for survival at home. The slow economic recovery from the financial crisis has made shoppers fixate on price and opened the gates to German price warriors Aldi and Lidl, who have both passed the dinner party test, where people are no longer ashamed to say they shop there (rather it has become a badge of honour).

Healthy living

Brexit was another blow. Weaker sterling has done little to help UK-focused grocers, but instead has pushed up input costs from imported food and clothing. However, the resilience of UK plc – the fastest growing major economy in 2016 – continues to inspire.

New figures out today from Visa show that consumer spending hit a two-year high in December, with food spending up 2.9% year-on-year. Recent analyst reports also paint a relatively positive picture. Jefferies reckons the supermarkets enjoyed a healthy close to 2016 but warned the outlook for 2017 is murkier, with challenged UK consumers continuing to embrace the discounters. 

Narrow margins

JPMorgan Cazenove warned that valuations are expensive and expectations high, and said the news flow is turning negative. Personally, I have been impressed by the way Tesco and Morrisons have fought back over the last couple of years. It has come at a cost, however, with one price war after another inflicting constant damage on margins.

British consumers remain pretty positive although the latest fall in the pound could aggravate inflationary pressures. Supermarkets face a tough choice: retain business by absorbing higher costs while further squeezing margins, or pass price hikes on to customers and risk losing more ground to the German firms.

Food, glorious food

Investors who swept the supermarkets out of their portfolios missed out on a bumper 2016, with Tesco rallying 40% and Morrisons up 57%. However, the falling pound, rising prices, stagnating wages and Article 50 uncertainty will make it hard to repeat the trick.

Tesco’s forward valuation of 20.3 times earnings does little to lift my spirits, especially given the lack of a dividend. I admire Morrisons feisty comeback but not enough to buy it at 20 times earnings. Sainsbury’s, which trades on a a forecast 12.3 times earnings and yields 4.8%, would be my pick of the three, but making up recent lost ground won’t be easy given current uncertainties. 

The doom-mongers said Brexit would be a disaster for the UK, until the FTSE 100 surprised everybody by rebounding to new highs.

However, this is still a phoney war and the turbulence may return with a vengeance as Prime Minister Theresa May once again stirs speculation that Britain will get a hard Brexit.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.