UK supermarket sector poised for strong cash generation, says Shore Capital

6th Jan 2015 10:50

After one of the worst years in living memory for investors and management in the British supermarket sector, broker Shore Capital expects 2015 to be another "very active and interesting" year, though the sector's nadir "may have been reached".Trading updates from the major supermarkets are due this week and will be closely watched, especially from Tesco on Wednesday, with Shore predicting negative like-for-like sales from Sainsbury and Tesco, with better results from Asda and Morrisons."Given the collapse of profits over the last 12-24 months, to a considerable degree reflecting a somewhat delayed reaction to market conditions, we see grounds to believe that the new year will be less disappointing from a performance and earnings outcome," wrote analysts Clive Black and Darren Shirley in a note to clients, but they lamented that there did not appear to be any "quick fix" to the sector's woes.While an improving economy and rising household incomes may see less public interest in shopping at discount supermarkets, helping the Big Four, what Tesco does to fix its in-store issues, and how this is received by British consumers, is viewed as one of the major factors influencing the future of the whole industry.In this respect, the analysts are particularly concerned about how Sainsbury's may be hit by any revival from Tesco in the UK, with vertically integrated Morrison's predicted to be a little more in control of its own destiny, while Asda is expected to have a "solid" year again. The sector may benefit from the oil price fall and active price-cutting strategies."The fall in grocery prices, motor fuel costs and, soon perhaps, home heating costs, could be one of the most positive drivers of volumes for some time for the whole trade," the pair suggest. "We sense that Tesco may have had a stronger volume than value trading performance in the Christmas trading period." "Volume growth would be especially welcome for the trade as would rising household incomes that may lead some customers to question the imperative to shop at the private label dominated grocery discounters such as Aldi and Lidl." Whilst no speedy change is forecast in the Big Four's underlying financial performance, stabilising trade and slashing capital investment means that the sector "could be entering a period of strong and sustained free cash generation"."On an ongoing basis, even with rising online penetration, which is centred on stores we should add, a leaner albeit low margin industry sweating its assets could bolster balance sheets and yet lead to a ?return to ongoing income streams for investors through dividends."The question of whether or not Tesco waives its final 2015 dividend pay-out and whether or not Morrison's will or should sustain its current dividend levels, remains on the lips of many industry investors.