Greedflation? There’s no evidence supermarkets are profiteering – and this is why

It is hardly surprising that, confronted with the highest levels of food and drink inflation since 1977, some people have concluded that supermarkets are “profiteering”.

Those people, apparently, include Liberal Democrat leader Sir Ed Davey, and the Unite union’s general secretary Sharon Graham.

Both have used that incendiary term over the past week, with Sir Ed going so far as to call for an investigation into the sector by the Competition and Markets Authority, the UK’s main competition watchdog.

The CMA was quick to close down that option when, on Monday, it made clear that “global factors” had been “the main driver of grocery price increases” and said it “has not seen evidence pointing to specific competition concerns in the grocery sector”.

It did though, presumably following a degree of ministerial coaxing, announce it was stepping up its work in the grocery sector “to understand whether any failure in competition is contributing to grocery prices being higher than they would be in a well-functioning market”.

The CMA’s instincts not to pursue a full-blown investigation into the grocery market are well-founded.

For there is absolutely no evidence to point to profiteering by supermarkets.

Take Tesco, the UK’s largest grocery retailer. It has reported a 7% drop in its operating profits for its retail businesses in the UK and Republic of Ireland in the financial year just ended.

It expects its profits for the financial year just started to be “broadly flat”.

Or take Sainsbury’s, the number two player in the market. It has recently reported a 5% drop in its underlying pre-tax profits for the financial year just ended and, like Tesco, expects profits growth to be flat this year.

These are probably the best indicators of what is going on in the market because Asda and Morrisons, the remaining two members of what used to be called the “big four” in recent years, have both recently changed hands and so their numbers will be less “clean” in the jargon.

But they too, like Tesco and Sainsbury’s, have also seen declines in their pre-tax profits for the most recent reporting periods.

The numbers don’t lie

Falling profits are hardly indicative of a sector that has been profiteering.

A look at some other financial metrics reported by the grocery multiples bear this out.

Tesco’s operating margin for the year just ended was just 3.8%, down from 4.37% the previous year and well down on the 5% or so that it and rivals – most notably Asda – has targeted historically.

Sainsbury’s has just reported a retail underlying operating margin of just 2.99%, down from 3.4% the previous year.

These are not, repeat not, the kind of figures one would expect to see from businesses that were profiteering. To put them into context, Apple has just reported an operating margin of 30.2%.

Another metric which gives the lie to any notion of profiteering among supermarkets is return on capital employed (ROCE) – a measure of how good a business is at generating a profit from the capital it puts to work.

Sainsbury’s has just reported a ROCE of 7.6% for the year just ended, down from 8.4% the year before, while Tesco’s ROCE has fallen from 7.5% to 6.6% during the last year.

Again, to put those figures into context, the Office for National Statistics reports that the typical rate of return achieved by a private sector company in the UK between July and September last year (the latest quarter for which figures are available) was 9.7%.

These numbers are just not what one would expect to see from a company that was profiteering.

The mistake made by people like Sir Ed and Ms Graham, who believe they have detected profiteering by supermarkets, is probably just to look at how big the headline profit is.

Tesco reported a headline retail operating profit of £2.3bn for the UK and Ireland for the year just ended.

A big number, yes, but – as has been shown above – not when set against sales of £53.3bn. These are huge businesses and with them come huge operating costs.

‘Shoppers are blessed’

As Clive Black, head of consumer research at the investment bank Shore Capital, put it to clients this week: “Tesco UK achieves circa 4% margins due to its scale (27% market share) but also a massive capital outlay in superstores that it would not expend today with current returns. Tesco is not opening any supermarkets, what does that indicate?

“Since the early 1990s, major UK superstore margins have fallen by 30% to 50% … Asda, Iceland, Morrison and Waitrose are largely loss-making to break-even at the profit before tax level.

“In the early 1990s, Sainsbury reported profits before tax of over £800m. We are forecasting less than £700m for the current full year after expending billions on capital expenditure.”

Mr Black, one of the City’s most experienced and highly regarded retail analysts, argues that “evidence of systemic profiteering is largely nonsense”.

He says that, on the contrary, the British public and government are “blessed to have one of the most advanced food systems in the world” which has brought down the proportion of household income spent on food from more than a third immediately after the Second World War to just one tenth now.

“That is a massive benefit of innovation, investment, technological change and entrepreneurship to society and an enhancement of living standards. More to the point, we have an amazing choice of safe product,” he added.

Not only is fierce competition in the grocery sector driving down supermarket profits. It may also be hurting other parts of the food and drink supply chain. Intense competition hurts suppliers of essential products such as milk.

Mr Black points out: “A decade or more ago, four pints of milk cost 155p to 160p. Prior to the pandemic, in 2019, that was 109p, despite rising costs in the interim. Presently, four pints of milk in UK supermarkets has fallen from 165p to 155p.

“The public kept quiet as milk was used, particularly by expanding German discount chains [Aldi and Lidl], as a loss leader, killing category profitability through those years.”

He suggests that government policies, such as regulations on packaging and clampdowns on migrant labour that have pushed up the operating costs of food producers, are – along with Russia’s invasion of Ukraine – among the main factors stoking food price inflation.

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‘Stupid statements’

The example he cites is tomatoes. When bad weather hit tomato production in Spain and North Africa recently, leading to shortages, there were gaps on the shelves of some supermarkets in the UK.

Mr Black explains: “The UK government decided not to support domestic glasshouse growers on energy or labour access and so, understandably, said folks emptied their facilities.

“Continental Europe, which tends now to have higher base food prices and elevated food inflation too, did not go short of such products while the UK did. Why? Well, because the intense competitiveness of the British market meant that African and Spanish product followed the money and, with little domestic produce, the availability matter was compounded.

“If anything shows the stupidity of Mr Davey’s supermarket profiteering statements, then tomatoes display all.”

Still unconvinced?

Well, take a look at the company share price charts.

Strip out the impact of share splits or consolidations and shares of Tesco, despite rallying by nearly 18% since the beginning of the year, have been changing hands this week at the same price they were back in November 2000.

Likewise, shares of Sainsbury’s, despite having risen by 27% so far this year, have been trading this week at the level they did back in September 1990. That is despite billions of pounds worth of investment by both in the intervening decades.

Supermarkets profiteering? Some of their long-suffering shareholders would probably be thrilled if they were.