Like Colruyt, the retail sector is going through a difficult period between rising prices and pressure on household budgets. However, a sharp correction opens up opportunities, in particular, if accounting traps are identified.
Listed on the stock exchange in 1977, Colruyt has grown into an indispensable asset over the years. In the spring of 2019, the share price topped €67 after the shares split 500: 1 for 10 in 1990 and 1999 and 1 for 5 in 2010. The trend changed drastically on June 19, 2019, when distributor de Hal warned that strong competition in the Belgian market was taking a toll on its margins. The title fell over 15% in one session, the worst drop in its history.
Listed on the stock exchange in 1977, Colruyt has grown into an indispensable asset over the years. In the spring of 2019, the share price topped €67 after the shares split 500: 1 for 10 in 1990 and 1999 and 1 for 5 in 2010. The trend changed drastically on June 19, 2019, when distributor de Hal warned that strong competition in the Belgian market was taking a toll on its margins. The title fell over 15% in one session, the worst drop in its history. Since then, Kolruit has not recovered. The name certainly created some illusion in 2020 as consumers rushed to supermarkets in the midst of a pandemic. But the soufflé fell quickly. Since the end of 2020, its market share has begun to decline. Explanations varied, such as the development of the Dutch brand Albert Heijn in Flanders and the reduced presence of the distributor in convenience stores. Last December, Colruyt announced that it had lost almost a third of its profit potential due to a decline in operating margins from 6.2% to 4.2% in the first half of the 2021-2022 financial year. Decline in profitability as a result of commodity price inflation and increased competition caused, in part, by the Group’s maintaining its market share. This event led to a clear devaluation of share in the stock market: Colruyt, having lost its distributor bonus, was able to increase market share without reducing its margin. In three years, stocks have lost 57%, much worse than what happened during the salami crash (2000-2003) or the Great Recession of 2008. Colruyt’s fall was reinforced by a correction that was widespread in the distribution sector. Thus, in Europe, the Stoxx 600 Retail has fallen by almost 30% over the past six months. And in the US, S&P Retail fell 26% over the same period. Walmart, the world’s largest retailer with $576 billion in annual sales and 2.3 million employees, suffered its biggest drop since 1987 and fell 19% in the three days following the release of quarterly data in May. In general, the downtrend has accelerated since the end of February due to the Russian invasion of Ukraine. The surge in prices for raw materials and energy is actually fueling inflation and distributors’ fears. On the one hand, household purchasing power and therefore sales are under pressure. On the other hand, costs rise as a result of rising prices for goods, premises (rent, energy) and wages. Finally, the last problem is the growth of stocks. Severe supply chain disruptions have forced distributors to increase their purchases and inventory to limit the risk of shortages. In the US, Bloomberg reports a 26% increase in inventories, or $44.8 billion per year. This affects profitability due to higher storage and financing costs in the face of rising rates. In addition, many distributors, having misjudged the evolution of consumer demand at the end of the pandemic, are forced to cut prices on certain products in order to eliminate their stocks. Managing these stocks is now so important to the sector that valuing them has become a major issue for distributors. At this level, remember that there are three main methods of inventory accounting. First: FIFO (First In First Out), when it is considered that the goods sold are the oldest of the purchased ones. Second: LIFO (Last In First Out), when it is assumed that the sold products were bought last. Third, the weighted average unit cost (WACC), when a company uses the average purchase price of its shares. In times of rising prices, a FIFO company captures a higher rate of return (selling old products bought at a lower price) and sees the value of its inventory increase faster. This is especially the case for Amazon, Lowe, Colruyt or Casino Guichard Perrachon. Conversely, a distributor using the LIFO method, such as Target, Macy’s, or Carrefour, is directly under pressure on its profitability as it accounts for the higher price of the latest products purchased for its sales. Tesco, Sainsbury’s or Metro AG use the more limited impact CUMP method. Many groups also combine different methods such as Walmart (LIFO in the US, FIFO internationally), Costco (LIFO in the US, FIFO internationally) or Ahold Delhaize (FIFO or CUMP depending on the product). The expected stabilization of inflation in the coming years will change the situation. Then FIFO distributors will struggle to recover their margins. Another important element in the retail sector is the dynamics of market share. Rebuilding these shares is often a long and tedious process as it involves many aspects of the strategy: price positioning, location (convenience stores vs. peripheral stores), outlet type (supermarket vs. hypermarket), e-commerce, marketing investment. As for Belgium’s listed distributors – remember that Aldi and Lidl are unlisted global giants – Carrefour seems to be in a better position. The group recorded an increase in market share in all of its key countries (France, Spain, Brazil) in 2021 and in the first quarter of 2022, in particular due to its presence in e-commerce and convenience stores. It stabilized its operating margin in 2021 at a fairly low level (3.1%), leaving room for improvement, which the group wants to exploit. This recovery and this good outlook has not escaped the markets as Carrefour reported a 34% gain over the past six months on Euronext Paris. Therefore, it is preferable to target a downturn, even if the valuation remains reasonable (12 times the gains expected in 2022, according to the consensus). Half-year results (expected July 27) could be hurt by Carrefour’s inventory LIFO method, but this bodes well for the long term. Read also | Carrefour lost 7% of its turnover in Belgium at the beginning of the year. In turn, Ahold Delhaize has experienced a normalization of its operations since the pandemic, from which it has clearly benefited, in particular, due to its strong presence in e-commerce (Bol. com). As such, its operating margin fell to 4.2% in the first quarter, in line with its historical performance. The Dutch distributor received shares in its main markets, namely the US and the Benelux countries. In terms of valuation, the stock quotes less than 12 times its expected earnings for this year, which is a fairly favorable multiple given the robust structural growth, thanks in part to its strong presence in the United States (over 60% of sales). The latter are experiencing stronger economic and demographic growth than Western Europe. As such, analysts are fairly confident in 19 of 27 buy recommendations in May, especially as Bol.com’s planned IPO in the second half of the year could speed up the repricing of the title. As for Colruyt, the group quickly reacted to the loss of its market share by strengthening its price positioning, and the stock no longer represents a premium (12 times expected earnings, according to Degroof Petercam), despite the drop in earnings. However, betting on Hal’s distributor is premature. On the one hand, the publication of annual figures on June 14 will be decisive in assessing the effectiveness of the current strategy. On the other hand, its FIFO inventory pricing method risks prolonging pressure on its margins. Internationally, Walmart continues to be hailed by analysts, with 32 buying tips out of 41 opinions in May. However, the giant started its 2022-2023 fiscal year very poorly with below-expected profits, and forecasts have been revised down for the full year: abandoning its growth target of 5% to 6% of its profits. However, analysts appreciate its investment in e-commerce over the past 10 years, which has placed it second in online sales in the US, behind Amazon and ahead of eBay. However, according to global e-commerce provider Edge by Ascential, this will not be enough to maintain market share in the US by 2026. However, Costco must increase its market share in the US from 3.8% in 2021 to 4.4% in 2026. The group also has significant potential for international development due to its atypical model. In order to take advantage of discounts in their warehouses (in the basic layout), the client must pay a membership fee. A formula that works as Costco shows comparable growth of 8-10% per year in the US and is (gradually) evolving around the world: Canada, Mexico, UK, France, Spain, Korea, Taiwan, Australia. , etc. Financially, his customer contributions make up the bulk of his profits, and his gross margin is very low at 12% compared to 24% for Walmart or 27% for Ahold Delhaize. Its mixed method of inventory valuation (with LIFO dominating) should limit the impact of rising prices on profitability. However, this is clearly a long-term investment with an expected P/E of 34. If you prefer to take advantage of low cost opportunities, you may want to look into the UK. Valuing their shares using the intermediate CUMP method, the two leaders, Tesco and Sainsbury’s, have expected price-to-earnings ratios of 12 and 10, respectively. Both stocks are also down more than 50% from their far-off highs in 2007. Admittedly, 10 years have accumulated difficulties with the local development of the German discounters Aldi and Lidl, the volatility of the pound sterling and the numerous disruptions in the supply chains associated with Brexit and the pandemic. After years of restructuring, Tesco appears to be finally reaping the rewards of its strategy. In terms of price positioning, the British leader has been increasingly able to match Aldi and has gained market share in the past year. In terms of results, its operating profit increased by 58% during the 2021-2022 financial year to £2.8bn. For 2022-2023, the British leader foresees stabilization, despite difficult economic conditions. One of its main assets is the Clubcard loyalty program, which has over 20 million UK households and about which the group uses all the data. Thus, analysts are confident of 13 positive recommendations and a total of 6 that should be maintained, while predicting better results every year until 2025 (at least). Sainsbury’s is struggling to adjust to current conditions and its operating profit is expected to fall by 5-15% in the 2022-23 financial year. However, the distributor is ahead of its debt reduction program and has managed to strengthen its market share since last year. So the very low valuation (8x earnings compared to last fiscal year) suggests recovery prospects once things improve. The name is also speculative, as private equity firms have already shown interest in a second UK distributor.