Although inflation has led to lower volumes and margins, we still see grocery retail as largely resilient to downturns.   This is mainly because most of their products are nondiscretionary. Brand image and strong market positions remain distinguishing factors, especially for supermarkets, while hypermarkets suffered more from changing consumer behavior during high inflation, leading to a decrease in market share. The high penetration of private labels in Europe--now making up 38% of total fast-moving consumer goods sales, according to consumer analyst company Circana--helps European retailers retain customers that trade down. In general, retailers have significant ability to play on the product mix to mitigate the impact of lower volumes and higher inflation to preserve margins.

Key credit risks for grocers are strong competition from discounters, a low-margin business model, a continued need to invest in stores, and shareholder remuneration expectations.   Increased competition in all major European markets, especially from German discounters Aldi and Lidl, is changing the pricing strategy of grocers we rate, most of which operate supermarket and hypermarket store formats. Discounters increased their market share in Western Europe to 19.3% in 2022, from 17.7% in 2019. To remain attractive to customers, grocers are focusing on product range differentiation, including organic and both discount and premium private label products. We are also seeing high investment in store refurbishment and IT/logistics infrastructure to offer additional services, such as online delivery, click and collect, and smaller store formats. These initiatives are leading to relatively high capital expenditure as a percentage of sales of between 2% and 4%. Listed companies also face investor expectations of regular shareholder remuneration, which is also constraining meaningful deleveraging.

Grocers with an investment-grade rating are typically larger players with strong market positions in their home markets and some geographical diversification.   Companies on the better end of the speculative grade category ('BB+' and below) are midsize and have limited geographical diversification, counterbalanced by a strong regional market share. The lower speculative-grade category mainly comprises smaller companies, which offer more specialized product ranges, such as fresh or frozen food.

Industry Outlook

We expect low-single-digit revenue growth in 2024 as inflation normalizes.   Revenue growth rates peaked at around 10% in 2022 and will have reduced to below 5% in 2023 as inflation has slowed. Growth will be constrained in 2024; first, by inflation, which we expect to slow to 2.9% in the eurozone and to 3% in the U.K.; and, second, by limited upside potential for volume increases. Grocery volumes peaked in 2020, the first year of the COVID-19 pandemic, and decreased to below the pre-pandemic levels in 2022 as inflation soared and consumers became more vigilant on their spending.

Chart 1

In the first half of 2023, rated European retailers reported revenue growth of 8.1% and stable EBITDA margins.  This showed they were able to pass price increases through to customers. Yet, even though revenue growth exceeded eurozone inflation (harmonized indices of consumer prices; HICP) of 5.5% in June 2023, it was below food inflation of 12.6%, highlighting continuous pricing pressure driven by persistent industry competition and weak volumes.

We expect average basket sizes will be smaller in 2024 and customers will continue to switch to private labels.   While we expect smaller average basket sizes, the nondiscretionary nature of grocery purchases will lead customers to make more frequent grocery runs. We also expect more consumers to switch to private labels. The high penetration of private labels in Europe, for which supermarkets aim to have the same entry price point as their discount peers, puts European retailers in a good position to retain trade-down shoppers, build customer loyalty, and defend their top lines and gross margins.

We predict that EBITDA margins will recover slightly in 2024, after dropping in 2022, even though the grocery sector is very price-competitive.   Smaller and more specialized grocers have higher margin volatility. As customers have become more price-sensitive, the specialized grocers, such as Esselunga in Italy and ZF Invest in France (Grand Frais' fresh food segment), had decreased their operating margins to remain price-competitive. Larger and more diversified grocers operate with structurally lower EBITDA margins, but also benefit from lower volatility and are in a better position to pass on prices.

Margins should recover gradually but are not expected to reach pre-pandemic levels of 2019.   In 2024, we forecast that food retailers will see moderate improvements of up to 110 basis points (bps) in their median EBITDA margins compared to the lows of 2022. Yet, we expect they will still be 65 bps below 2019. Our forecast takes into account moderating inflation rates on the cost of goods, freight, and energy, offset by higher labor costs.

Chart 2

Market structures are heterogeneous across European markets.   In France hypermarkets have the highest market share of around 38%. German discounters Aldi and Lidl entered the French market later, leading to a relatively low combined share of about 8%. In Germany, by contrast, discounters hold the highest share with around 35% (including Netto and Penny, the discount brands of market leaders Edeka and REWE). However, hypermarkets and smaller local stores play a less meaningful role in Germany. The Italian market has a relatively high share of smaller local grocers of about 12%. The U.K. has a relatively low share of supermarkets of around 21%, and a growing share of discounters with around 13%.

We believe smaller and specialist retailers will find it more difficult to invest as much as larger investment-grade peers in delivery services and other online offerings that customers increasingly expect as standard but which come with significant upfront investments and costs. We think most online delivery operations are not fully profitable after all costs, which limits the potential for smaller retailers to compete aggressively in this space.

Chart 3

Market consolidation should continue but at a lower scale and slower pace.   This could mean, for instance, acquisitions of a portfolio of stores rather than large outright acquisitions, given that rated retailers, especially those which are well capitalized, already have substantial market shares.

The French market is especially competitive, reflected in comparably low EBITDA margins, which hints toward further market consolidation.   Market concentration is lower in France, where the top five players represent 57% of the market, than in Germany, where they make up 76%. The high share of hypermarkets, a destination large-basket format, and no very clear market leader such as Tesco in the U.K., make France very price-competitive.

Chart 4

The ongoing financial restructuring of French retailer Casino, Guichard-Perrachon is offering other market players the chance to increase their store footprint.   In January 2024, Casino signed an agreement with ELO's subsidiary, Auchan Retail, and French retail group Les Mousquetaires to sell 288 stores, 98 of which will be acquired by Auchan--mostly hypermarkets--and 190 by Les Mousquetaires-Intermarché, mostly supermarket formats. That said, Leclerc will remain the market leader and may attempt to consolidate its leadership position by re-investing in price.

In addition, the recent transaction in the U.K. between ASDA and EG Group and the potential Motor Fuel Group (MFG) and Morrisons forecourt deal, also highlight potential for sales of a portfolio of assets such as stores and fuel stations to manage elevated financial debt of sponsor-owned companies. We also expect grocers to enhance their convenience store presence, and potentially expand the scale of food-to-go offerings and ancillary services.

Retail alliances appear to have lost some of their appeal in recent years as membership continues to evolve.   International retail alliances negotiate on behalf of their members with manufacturers, leading to a better negotiation position than each member on its own. There are three major international retail alliances in Europe:

• Agecore, made up of Colruyt (Belgium), Conad (Italy), Coop (Switzerland), Eroski (Spain) and others;
• Eurelec/Coopernic, consisting of Ahold Delhaize (Benelux), E. Leclerc (France), REWE (Germany), Coop Italia (Italy), and others; and
• Epic/Everest, comprising Edeka (Germany), Picnic (Netherlands), Jumbo (Netherlands), Système U (France), and Migros Group (Switzerland), among others.

The European Commission cleared the way for AgeCore and Coopernic after an investigation found no evidence of anticompetitive effects from the retail alliances.

In our view, these purchasing partnerships are complex, and often yield lower incremental margin benefit, especially to the larger retailers, which already benefit from substantial scale. We think this explains why several large food retailers such as Tesco, Carrefour, and Metro have exited their arrangements in recent years.

Peer Analysis

Grocers with an investment-grade rating distinguish themselves by their large revenue size, strong domestic market shares, and some geographical diversification.   Koninklijke Ahold Delhaize, REWE, Carrefour, and Tesco post more than €70 billion in annual revenues, hold leading market positions in their respective home markets, and are geographically diversified. The withdrawal from international markets, such as ELO's (Auchan) departure from China and Tesco's from Malaysia, Thailand, and Poland, indicate a continued trend for European retailers to divest international markets that has been ongoing for the past several years. Auchan differs from its investment-grade peers in that it is smaller (€33.5 billion sales in 2022) and is not the market leader in its home market France (No. 5). It nevertheless has a notable international presence in Spain, Russia, Poland, Portugal, and Romania.

Companies in the upper speculative-grade category are smaller, but also have a strong regional presence.   Esselunga, the Italian food retailer, has most of its stores--around 60% in 2022--in the Lombardy region. Maxima Grupe has a strong market position of around 25% in the three Baltic states, which account for around 68% of the group's revenue in 2022, despite a gradual diversification toward Poland.

In the lower speculative-grade category, grocers are smaller and more specialized on specific categories, such as fresh or frozen food.   They have a distinctive value proposition that enables somewhat higher but also more volatile margins. Picard Groupe and WD FF (operating as Iceland Group) are both frozen food specialists, with Picard being a pure player in France, while Iceland also offers a larger variety of non-frozen food with a geographical focus on the U.K. ZF Invest and Euro Ethnic Foods are both part of the Grand Frais brand, which specializes in fresh food in France. Eroski and Uvesco are Spanish generalist grocers, both in the Basque country, with a strong regional focus and limited size, as they do not have full coverage in Spain or diversification beyond the national border.

Chart 5

Larger grocers have fairly stable but structurally low EBITDA margins, while smaller regional players have higher margins but exhibit more volatility.   In the investment-grade category, Ahold Delhaize stands out globally and has the highest EBITDA margins at around 8.5%, underpinning its 'BBB+' rating, the highest of the European peer group. REWE and Tesco both achieve 6.5%-7.0% EBITDA margins, while the French retailers Carrefour and ELO (Auchan) are at the lower end of the peer group with 5.0%-5.5%.

Chart 6

Among the regional grocers, the Spanish peers Eroski and Uvesco have solid profitability, with EBITDA margins above 10%.   Regional players adjust their value proposition to local preferences, creating higher customer loyalty, and benefit from shorter, more efficient supply chains, which is a key competitive advantage, especially for fresh food.

Esselunga and Maxima have lower EBITDA margins of 7%-8%, which is still higher than the investment-grade companies. Esselunga's EBITDA margin declined in recent years, because of its more aggressive pricing policy, but we expect this to normalize again. U.K.-based Market Holdco's (Morrisons) EBITDA margins are between 4.5% and 5.5%, which we view as an outlier, diluted by a high revenue share from fuel, that typically has a low-single-digit margin. U.K.-based Co-operative Group has structurally lower margins than many peers, diluted by the wholesale segment, which primarily supplies private label products to a joint buying platform on a cost-recovery basis. WD FF (Iceland Group) has a discount focus and a significant share of frozen food.

Chart 7

Among specialist grocers, Picard and Euro Ethnic Foods have the highest margins.   Euro Ethnic Foods, the grocery and beverage segment of the French grocer Grand Frais, has higher EBITDA margins (above 20%) than ZF Invest, the fresh food segment of Grand Frais. French frozen food specialist Picard has structurally high margins.

Chart 8

The capital expenditures for larger investment-grade grocers vary between 2% and 4% of sales.   REWE, Ahold Delhaize, and ELO (Auchan) invest the most. REWE and ELO (Auchan) stand out, as both companies are increasingly investing in real estate. REWE has made the strategic decision to own more of its store and logistics network, especially in Germany.

Chart 9

Among the regional grocers, Esselunga stands out, with more than 4% of revenues expected to be invested in capital expenditure over the next two years.   Esselunga develops and owns the majority of its stores, and invests in the growth of its e-commerce operations in Italy, which translates into higher capex.

Chart 10

ZF Invest and Euro Ethnic Foods have high capital expenditure, with more than 4% of revenues expected to be invested in 2024.   Key drivers of this elevated spending are the rapid expansion of about 25 new stores per year and the development of side concepts such as Fresh, targeting proximity shopping, and Monmarché.fr, entering the Parisian market through online.

Chart 11

We expect grocers to mainly to use their operating cash flows for growth capex, lease payments, and shareholder remuneration, thereby limiting deleveraging.   While the characteristics of grocery retailers provide more stable operating cash flows than retailers of nondiscretionary products, our rated grocers are investing heavily. Investments, combined with high lease payments can lead to negative free operating cash flow (FOCF) after leases, as in REWE's case. At the same time, listed retailers are constrained by shareholder remuneration, as is evident for Tesco, Carrefour, and Ahold Delhaize. We therefore forecast 2023 discretionary cash flows (DCF) after leases will have been negative across our rated universe.

Chart 12

We expect companies' debt, as adjusted by S&P Global Ratings, to increase moderately over the period 2023-2025.   This is due to negative discretionary cash flow (DCF) after leases as well as higher lease liabilities related to store expansion and inflation-related rent adjustments. This is offset by continued EBITDA growth, leading to stable S&P-adjusted leverage for investment-grade grocers at around 2.5x. For the speculative-grade issuers, for which we anticipate a more meaningful margin recovery, we envisage a leverage reduction to 4.5x in 2024 from 5.6x in 2022.

Chart 13

Ratings Profile And Outlook

Grocers with a strong position in their home market and a presence in several countries have a larger revenue base and a clear leverage commitment, often resulting in an investment-grade rating. Companies with a presence in a specific region or specialized in a certain category, such as frozen or fresh food, have mostly speculative-grade ratings of 'BB+' or lower.

Chart 14

The food retail sector is resilient to macroeconomic shocks, as shown by 87% of rated issuers retaining a stable outlook.   This is despite the challenges in 2022 and continued weakness of the macroeconomy. Only Esselunga and ELO (Auchan) have a negative outlook. Esselunga's negative outlook reflects the challenging operating environment, with weaker consumer demand and surging costs, constraining the company's profitability. Auchan's negative outlook reflects its structural weaknesses in France and the deterioration of its credit metrics, also due to its significant presence in Russia. Upside potential for ratings in the food retail sector is constrained by the continued requirements for capital expenditure and the expectation of shareholder remuneration for listed issuers.

Chart 15

Besides the pure food retailers we rate several companies for which food and convenience offerings support their credit profiles.  Food and convenience products are a meaningful contributor to these companies' business performance. It is relevant for forecourt and convenience operators such as EG group (B-/Positive/--) and CD&R Firefly 4 Ltd. (Motor Fuel Group; B/Positive/--). Food at Marks and Spencer (BBB-/Stable/A-3) stores makes up approximately 50% of U.K. gross profits. We also rate food-related businesses with business models that rely less on the footfall and proximity of stores to end customers than is the case for food retail: HelloFresh (BBB-/Stable/--) delivers meal kits directly to customers' homes based on a flexible subscription model and Metro AG (BBB-/Stable/A-3) is an exclusive food B2B company, mainly supplying hotels, restaurants, caterers, and traders.

Ahold Delhaize and REWE both emerged stronger from the pandemic, resulting in rating upgrades.   We upgraded Ahold Delhaize to 'BBB+' with a stable outlook in 2023, which makes it the highest rated food retailer in Europe, as the company gained market share while maintaining the highest margins in the sector. We upgraded REWE to 'BBB' with a stable outlook in 2022 on improved scale and tighter financial policy. The ratings on Carrefour (BBB/Stable/A-2) and Tesco (BBB-/Stable/A-3) proved resilient during the pandemic and high-inflation environment, both ratings remaining unchanged since 2019.

The French grocer ELO (Auchan) was negatively affected by cost-inflation and the Russia-Ukraine war, leading to a revision of the outlook to negative and affirmation of the 'BBB-' rating in November 2023.   Prior to the pandemic, the rating on ELO was 'BBB-' with a negative outlook. However, we revised the outlook to stable in November 2020, after the company sold its operations in China and partially used the funds to repay financial debt. The current negative outlook reflects the company's structural weaknesses in its core French market, characterized by declining market share and comparably lower EBITDA margins, which in our view pose long-term challenges to the group's profitability and cash-flow generation. Moreover, the company has a notable presence in Russia, and we have tied the rating triggers to pro forma credit metrics excluding the contribution from Russia.

We downgraded and subsequently withdrew the ratings on Casino, Guichard-Perrachon in August 2023.   Casino had comparably high pricing already prior to the cost inflation that started in 2022, leaving only limited headroom to pass higher costs to customers. As customers became more price conscious they shifted to competitors, resulting in sharp volume and revenue contraction in its super- and hypermarkets. This, combined with years of significant cash-burn, ultimately translated in liquidity shortfall and forced the company into a conciliation procedure and later into an accelerate safeguard procedure to restructure its debt. We downgraded Casino to 'D' on a missed interest payment and withdrew the rating in August 2023.

In the speculative-grade category, there have been three downgrades since 2019 mainly due to lower profitability as inflation accelerated.   We downgraded the U.K.-grocer Co-operative Group to 'BB-' with a stable outlook in 2022 due to lower profitability and cash generation amid cost inflation and supply-chain disruptions. Esselunga, currently 'BB+' with a negative outlook, was downgraded in 2020 as leverage increased due to the squeeze-out of minority shareholders, which was mostly debt-funded. ZF Invest, the fruit and vegetable, seafood, and diary segments of the French grocer Grand Frais, was downgraded to 'B-' with a stable outlook in June 2022, as cost-inflation led to lower margins.

Since 2019 we have assigned five new ratings on food retailers, all in the speculative-grade category.   The ratings on Euro Ethnic Foods (B/Stable/--), the grocery and beverage business of the French grocer Grand Frais, and Market Holdco 3 Ltd. (B/Stable/--), which runs the U.K.-based grocery retailer Morrisons, have remained unchanged. We also assigned ratings on the two Spanish grocers Eroski (B+/Stable/--) on December 2023 and Uvesco Food Retail (B/Stable/--) in August 2022. ZF Invest was initially rated 'B' with a stable outlook in July 2021 before being downgraded to 'B-' in June 2022.

Table 1

Related Research

• Industry Credit Outlook 2024: Retail and Restaurants, Jan. 9, 2024
• European Retailers' Margins Are Unlikely To Regain Their Pre-Pandemic Strength, Nov. 7, 2023
• Economic Outlook Eurozone Q1 2024: Headed For A Soft Landing, Nov. 27, 2023
• U.K. Economic Outlook 2024: More Stagflation Ahead, Nov. 27, 2023