How much stock will rise as stores battle it out in the cost of living crisis?

Street retailers are often on investors’ shopping lists. Several are among the largest listed companies in the UK and have a history of paying out sums to investors even in difficult times. Companies like M&S, Tesco and Sainsbury’s have shown resilience for more than a century, weathering everything from World War II rationing to the challenges of the pandemic.

But as the cost of living soars, high street giants face a new challenge. Their costs increase as the price of raw materials, labor and fuel explodes. At the same time, their customers control their expenses to make ends meet.

In this difficult climate, there will be winners and losers. Investors who identify the retailers best positioned to ride out the cost of living crisis could be rewarded, although they may take a while to emerge. But put the wrong ones in your cart and it could cost you.

Tough market: Cost of living pressure forces buyers – and retailers – to be creative

Why supermarkets are a mixed bag

Supermarkets are finding it harder to get shoppers to part with their cash than they have in years. Half of all households are buying less food due to the cost of living crisis, according to the Office for National Statistics (ONS).

Even so, supermarkets can prove more resilient than other types of retailers. Shoppers can cut back on discretionary spending in tough times, but they will still have to buy food, regardless of price.

Jason Hollands, managing director of wealth manager BestInvest, says food retailers could even spy on growth opportunities in this climate.

“As people are more careful about what they put in their shopping carts, food is a staple and so demand is relatively constant,” he says.

“As an increasing number of shoppers switch from branded items to own brand products, this actually benefits the larger chains, as they generally realize a higher profit margin on their own brand products.”

James de Uphaugh, who heads Liontrust Asset Management’s Edinburgh Investment Trust, adds that the winners in this environment will be those who limit price increases and provide attractive options for customers who want to switch to cheaper brands.

“Supermarkets have been among the heroes of the pandemic – they have powered the nation through incredibly difficult times, with ever-changing social restrictions and disrupted international supply chains,” he says. “Today you can see them taking up the torch.”

Investors looking to buy into UK supermarkets will find the cupboards relatively empty. Morrisons was taken over last year by US private equity group Clayton, Dubilier & Rice, while Asda, Lidl and Aldi are private companies.

However, shares of Tesco, Sainsbury’s and Marks & Spencer are all listed on the London Stock Exchange and are therefore easy to buy and sell for UK investors. Of these, Tesco is “comfortably” the favorite of Richard Hunter, head of markets at investment platform Interactive Investor.

“Even in the midst of rising inflation, Tesco is increasing its market share in what is a notoriously competitive industry,” he says.

Tesco is attracting shoppers with programs such as Aldi Price Match, which ensures it won’t charge more for key items than its main budget rival Aldi.

Tesco is also hanging on to its customers by offering lower prices on a range of everyday items to members of its loyalty scheme, Clubcard.

Additionally, Tesco recently pretended to be on the side of struggling buyers by refusing to stock baked beans and Heinz soups when the manufacturer tried to raise prices. This too can help build customer loyalty.

Hollands also likes Tesco because it currently offers investors a reasonable dividend income of 4.3% on their shares, or £4.30 a year for every £100 invested.

“The chain also owns food wholesaler Booker, which supplies businesses across the UK,” says Hollands. “It creates operational efficiencies, which helps reduce costs.”

Rival Sainsbury’s is struggling more with current pressures. The shares are down 23% this year. Hunter warns: “The jury is out on Sainsbury’s immediate prospects right now.”

However, there are a few positives for the retailer. It is spending £500m to absorb wholesale price rises, rather than just passing them on. It’s a good sign that Sainsbury’s understands the pain its customers are feeling and how important price stability is to them. And the dividend yield is currently at an “extremely generous” 6%, says Hunter, as Sainsbury’s tries to convince shareholders to stick with it and wait for better times.

There is also always a chance that a hungry private equity firm could take over Sainsbury’s in the same way Morrisons did, which would be good news for investors entering at this price.

Marks & Spencer shares are also down, down 44% so far this year. However, Mark Wright, fund manager at Momentum MultiAsset Value Trust, believes the food and clothing retailer has a chance to perform well in the current environment.

“Struggled consumers may wish to save money by eating less in restaurants, but still want to treat themselves to delicious food,” he says. M&S clothing is also seen as some of the best in the UK, according to a recent YouGov poll. This could stand him in good stead as buyers strive to make their money grow. M&S shares are yielding just over 5%.

Winners and losers on the main street

According to the ONS, six in ten households are spending less on non-essential items as budgets get tight. However, we are cutting spending in some categories more than others.

Spending on clothing in particular is falling as shoppers choose not to upgrade their wardrobes. As a result, it may be difficult for investors to find good apparel retailer options for some time. However, households still engage in hobbies, pets and inside the home.

As a result, Pets at Home could be a “recession winner” in retail, says Jonathan Pritchard, an analyst at investment bank Peel Hunt. “People treat pets as part of the family and will always make sure they are fed and cared for,” he says. “The dog is one of the last things to do in a downturn.”

He believes that while growth may stagnate for the pet retailer, it is unlikely to reverse, adding: “The shares are down 38% this year and as a result look cheap.”

Home goods retailer Dunelm could show resilience, says Pritchard, as households look for affordable ways to brighten up their homes.

“Dunelm delivers value to customers and has invested heavily in all of its sales channels, so it’s equally comfortable selling in edge retail stores as it is online,” he says.

The shares are down 44% this year. So if you believe in the long-term potential of Dunelm, they might seem like good value for money.

Investing in electronics retailers right now is probably only for the brave. It is true that even in difficult times, people still need to replace old laptops and like to buy new phones.

However, they will likely do so at a slower pace – and stick with their old pattern for a little longer.

Tech retailer Currys warned last week that the current retail environment was “not very favourable” – despite posting strong results for the full year.

The retailer launched a new Pay Delay program to allow customers to defer payment for their purchases for a year without paying interest.

If it works, it could help Currys attract customers and rejuvenate sales. If not, it can just pile up debt problems and reduce sales later on. The shares are down 42% this year.

Spread the risk by investing in a fund

Determining which retailers offer the best opportunities for investors is a difficult challenge in this climate.

Many investors may prefer to invest in a fund that holds more than one. This way they are not dependent on the fate of just one or two retailers – and they have the help of an expert fund manager to make the calls.

A fund called Time: Commercial Long Income is one option suggested by Ryan Lightfoot Aminoff, senior research analyst at fund data group FundCalibre. His fortune is linked to the success of certain supermarkets in which ordinary investors cannot buy shares.

For example, it has a shopping park in Thorne, near Doncaster, which houses Aldi, among other stores. He also owns the building used by Asda in Gillingham, Kent.

Kyle Caldwell, fund expert at online investment platform Interactive Investor, highlights Supermarket Income Real Estate Investment Trust, which only invests in supermarket real estate.

“It has a dividend yield of nearly 5% and a good track record to date,” he says.

However, the investment trust is in demand and the shares are trading at a premium of almost 9%. This means that the shares cost nearly 9% more than the value of the trust’s underlying holdings.

Artemis Income is one of a number of funds that hold shares in several UK retailers. Tesco represents 3.2% of the fund.

The fund turned a £1,000 investment into £1,079 over three years.

Edinburgh Investment Trust counts Tesco and Dunelm among its top holdings and has turned a £1,000 investment into £1,140 over three years.

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About Barbara J. Ross

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