June 30, 2016

Is there retail life after Brexit?

Departures (photo: alice_photo/Fotolia_80256796_S)
Farewell Britannia: Either the Brits have made a big mistake, or they have ended one
The result of last Thursday's referendum on EU membership was about as surprising as the England vs. Iceland game in the UEFA Euro 2016! But, now that a small majority (52 per cent) of UK voters has plumped for Brexit, all of Europe will have to live with the consequences.

Although the decision is not binding for the government, political pressure on the successor of outgoing prime minister David Cameron will oblige him or her to trigger Article 50 of the Lisbon Treaty and begin what are likely to be acrimonious negotiations as from January 2017 with a 27-member bloc whose GDP has just shrunk by around 17 per cent.

Despite fears in Brussels that protracted negotiations could fracture the Single Market still further, the conclusion of new trade agreements is likely to be long and complex.

Greenland took three years to leave, but there fish was the only issue and population about that of a football stadium. The sheer complexity of the divorce will doubtless have all lawyers rubbing their well-manicured hands, but what will be the likely fallout from the Brexit bomb for retailers in the UK?

Mayhem on both sides of the Channel 

Photo: Alexandra Thompson/Fotolia_109809567_S
Somewhat ominously for the EU, more value was initially written off continental European bourses after June 23 than on the London Stock Exchange. Although other sectors such as banking, airlines and homebuilders took a bigger hit, UK retailers were also caught up in the general mayhem.

The share prices of UK grocers Tesco, Sainsbury and Morrisons, as well as Ahold, Carrefour, Casino and Metro Group on the other side of the Channel, were all down in the immediate aftermath. Here it should be remembered that markets have recovered from worse crises in the past.

Sterling takes a pounding

If the dramatic fall in the valuation of the pound on international currency markets continues, exporters will obviously benefit. It will also buoy the London stock exchange as around 75 per cent of corporate earnings on the FTSE 100 are made abroad.

Within around six months, a low sterling rate against the world's major currencies will create inflation from food to TVs as British retailers pass on higher import prices. However, the negative effects of this will be mitigated to the extent that the local grocery market has just experienced three successive years of deflation.

Investment research company Bernstein (cf. interview below) calculates that historically there has been 3.4 per cent inflation in food prices for every 10 per cent fall in currency.

Consumer electronics retailers such as Dixons Carphone will obviously find it more expensive to import non-food products. By the same token, a low sterling rate could benefit the balance sheet of leading grocer Tesco who, despite an increasingly streamlined foreign portfolio, still makes more than a quarter of its operating earnings outside the UK. Bernstein computes that this could boost ebit by £323m.

Photo: destina/Fotolia_109198388_M
As the euro also weakens in the aftermath of Brexit, the balance sheets of leading European retailers Ahold (NL), Carrefour (F), Casino (F) and Metro Group (D) could also profit from their substantial international holdings.

More worringly, the current political uncertainty is likely to create a freeze on investment and job creation. Increased unemployment would obviously hurt consumer sentiment, which could benefit Aldi and Lidl UK with their low-price offers, although this would primarily affect spending on big-ticket items such as cars and foreign holidays.

Dis-United Kingdom

Gainsaying the doom-and-gloom merchants in the "Remain" camp, who prophesy a flight of foreign investment from the UK, neither Aldi or Lidl give any indication that they might allocate capital towards other national markets. Both discounters, who source around two-thirds of their fresh produce locally, reiterate their commitment to Great Britain. A probable fall in commercial property prices would also benefit their ambitious organic growth expansions plans.

Other trade reactions to Brexit are given below. All hope for a speedy end to the current uncertainty and a return to business as usual. May a poll-weary and dis-United Kingdom as well as a Brexit-shocked world quickly regain their equilibrium.

We shall probably have to wait though now that the English have opened Pandora's box. North of the border, nationalists are demanding a second referendum on Scottish independence, and even London is petitioning for release from the UK. So perhaps the English vocabulary will soon be enriched by two new portmanteau words: "Sexit" and "Lexit".

Meanwhile, wily politicians, with former UK premier Tony Blair as their figurehead, are apparently plotting to overturn the referendum result in true EU style. It is unlikely that they will be able to call a second plebiscite just yet, but perhaps a new government with a mandate to stay in Europe will do the trick? After all, democracy is far too important a matter to leave to the electorate!


Podcast. Click arrow to listen to an audio version of the text:






"The UK will continue to eat"

Interview with Bruno Monteyne, Senior Analyst, European Food Retail, Bernstein Ltd


Bruno Monteyne, Bernstein Ltd (photo: Bernstein)
Mr Monteyne, Aldi and Lidl UK have confirmed to us in writing their commitment to the UK post-Brexit. Do you believe them?

Yes. Nobody has really any idea what will change, so I wouldn't expect them to make any hasty decisions. Ultimately, profits and returns on investment will drive their behaviour in the long term, which I am sure they're keeping a close eye on.

So was June 23 a black day or a golden day for Aldi and Lidl UK?

I don't think it was a particularly good or bad day for either of them. We shall continue to eat in the UK, and both will continue to thrive. There are many other things that have been happening which are far more fundamental to their trading outlook – just think of the two pricing shocks stemming from Tesco's Farm Brands and Amazon Fresh.

The most important structural factor for Aldi and Lidl is the price repositioning of UK supermarket competitors. The first thing that CEO Dave Lewis did after being parachuted in to effect a turnaround at market leader Tesco was to set more competitive prices on branded goods. Now, 18 months later, its Farm Brands range seems to be virtually unbeatable on price by discounters as well. Our own blind taste tests have also confirmed its superior quality credentials.

To what extent could the increased cost of doing business motivate Aldi and Lidl to allocate less capital to the UK and more to other areas within their present and/or future retail empires?

When their profits decrease towards or just below their cost of capital, we'd expect them to stop adding to their property pipeline. It would then take another 18 months for the pipeline to run dry. The main drivers of any such reduced profitability are the price shocks I have just mentioned, but Brexit might accelerate that time plan.

Aldi and Lidl have consistently grown faster than Tesco, Sainsbury or Morrisons since the financial crisis in 2008/09. Will their growth rate increase or decrease post-Brexit?

We believe that they will continue to grow rapidly, but at a lower rate than in the past. Brexit is likely to increase inflation, which will accelerate nominal sales growth for all retailers. So I don't see Aldi or Lidl as relative winners.

A continued devaluation of the pound will increase food price inflation in roughly six months. Won't this benefit Aldi and Lidl as low-price operators?

Yes, if inflation was also accompanied by a big recession that led to substantially higher unemployment.

But it is important to state that the starting point of food inflation today is very low. We therefore anticipate food inflation to go from minus 2 per cent to plus 2 or 3 per cent. Looking at historical trading patterns, food inflation of up to 2 per cent is not something consumers worry massively about. They only start to react by switching products and retailers when it exceeds 2 per cent.

Retailers cannot pass on higher input prices in full measure to consumers and inevitably have to take a hit in gross margin. Can Aldi and Lidl take the pain better than Tesco, Sainsbury and Morrisons because of their low-cost model, or will they be at a disadvantage because they lack local economies of scale?

I don't agree with your starting point. The pain of higher inflation is felt by all retailers equally and they do pass it on! What drives margin, however, is relative trading success.

Another major element in food inflation is the difference between wage and food inflation. When there is deflation, increasing wages make it hard for retailers. This especially applies to supermarkets because their wage bill as a percentage of sales is higher than that of the discounters. So during deflationary periods, margins are relatively better at the discounters.

But this situation reverses when there is food inflation. In relative terms, food inflation makes it easier for supermarkets to manage wage inflation and they have a corresponding advantage over the likes of Aldi and Lidl.

If negotiations between the UK and the EU are long and nasty, could British consumers boycott Aldi and Lidl as German retailers?

This hasn't been a major theme in the UK, except for Morrisons who like to remind people of their Britishness. I don't think that consumers see Aldi and Lidl as proxies for German politicians. Also, Germany (or Angela Merkel) often represents the softer voice of reason within the EU and has always tried to accommodate the UK, where possible.

I think Aldi and Lidl are respected and known for offering great value for money. I also don't think there are many people who are worried by their German ownership. Despite the Brexit vote, the UK is very open to foreign investment and has many global businesses of its own.

Aldi and Lidl UK state that around two-thirds of their fresh produce are sourced locally. This means that they have to buy the other third abroad. As most of this will be from the EU and will therefore have to be purchased in euros, won't this increase their cost of business?

Aldi Men's Marl Zipped Hoodie (photo: Aldi)
Aldi Men's Marl Zipped Hoodie
It's significant that they only mention fresh produce. Aldi and Lidl drive a lot of sales from their non-food offers (just think of the big rummage bins in their stores). Most of their non-food is inevitably sourced from outside the country because we don't make much in the UK anymore! Nonfood alone probably accounts for nearly a quarter of their annual sales.

They have also confirmed that their big trading events, e.g. French week, Spanish week etc., are sourced from their partners in Europe. Then you must add international dry goods brands such as cornflakes, baked beans, biscuits, nappies, chocolate, coffee, ketchup, sweets etc., which I assume are bought in conjunction with their sister companies in Europe.

But despite all this, Aldi and Lidl are still only slightly worse off than local UK retailers because most of them source important parts of their food range from abroad anyway.

Aldi's and Lidl's retail concept is based on a cost-efficient system of European standardization. If the UK decides on its own packaging rules, weights etc., will this be an extra cost factor for them?

Just because the UK wants to leave the EU doesn't mean that they are going to change their packaging rules! If anything, Great Britain will want to keep as close as possible to European norms. The issues the Brits really voted on were immigration and sovereignty. I don't think sovereignty of packaging rules was exactly what they had in mind!

Also, I would see the success of the Aldi model in the US and Australia as a sign that European sourcing and standardisation are not fundamental to the success of either Aldi or Lidl. Their concept is more about sourcing a small range with good quality at great prices supported by low staff costs and rents.

To what extent do Aldi and Lidl depend on cheap migrant labour in the UK, and how badly would it hurt them if the Brits put a stop to this?

I don't see any difference between the recruitment practices of the German discounters and any other UK retailer. They all benefit from cheap migrant labour.

Aldi and Lidl UK also employ continental European management. Would stricter laws on Europeans working in Great Britain create problems for them?

Those execs are not really the type of migrant workers that the British people want to stop coming in. Even if it became more complicated to move staff across borders, which would really surprise me, I am pretty sure they would both find plenty of talented Brits to help them run their business.

Just think, for instance, of the big thing Aldi has made out of paying English graduates a high starting salary. It should therefore have a good stockpile of talented local employees.


Photo: Stephen Finn/Fotolia_85004573_S

in Quotes





Aldi UK:
"Like other UK companies, we will be working through the implications of leaving the EU over the coming months, but our existing operations, future expansion plans and commitment to sourcing the majority of our products from UK suppliers will be unaffected. It is very much business as usual at Aldi."

Peter Giørtz-Carlsen, European Head of Arla Foods: "For Arla, it is important that a trade agreement is reached without import and export quotas or tariffs that limit the free movement of goods...
 
As a farmer-owned dairy company with 12,700 owners from seven EU member states, of which 2,700 are British, approx. 80 per cent of Arla's global revenue is generated in the EU and more than a quarter in the UK.
 
Most of our business in the UK is based on local production. However, to utilise Arla's European pool of 13bn kilos of milk in an optimal way, it remains critical that our products can move freely across the markets in which we operate.
 
In spite of the new challenges, the outcome of the referendum will not change the importance of the UK for the Arla Group as a key market." 

Anton Börner, President of the Federation of German Wholesale, Foreign Trade & Services (BGA): "The unimaginable has happened...it's deeply worrying that the world's oldest democracy has turned its back on us...The political and economic repercussions will be huge...With Brexit we have entered a new phase of uncertainty, which is poison for business...It can't be 'business as usual' in the EU any longer. The most important goals are now damage control and an end to uncertainty."

Helen Dickinson, CEO of the British Retail Consortium: "Now that a decision has been made to leave, it is important the Government moves quickly to expedite the process of disengagement from the EU. Without clarity, retailers, other businesses and hence the economy will suffer from a prolonged period of uncertainty."

Joachim Rukwied, President of the German Farmers' Union (DBV): "Europe isn't only a Single Market, it is also an area of political obligation and responsibility. This is why German farmers families view Brexit with great concern as to the stability of the Community and its capacity to reach agreement...

One can only hope that those with political responsibility in Europe's capital cities, including Brussels, have understood the message: They can no longer continue to administer the European idea as bureaucrats, but must start representing the people."

Eric Schweitzer, President of the Association of German Chambers of Commerce and Industry (DIHK): "Brexit is a setback for the German economy...In the short-term it is to be feared that there will be fewer German exports to Great Britain. Doubtless we can expect a further depreciation of the pound over the next few weeks...

The referendum has shown, however, that Europe is no longer something one can take for granted. We need a new offensive for Europe so that the EU can gain the support not just of the business community but of the people."

Oliver Süme, Board Member for Politics & Law at eco, (German) Association of the Internet Industry: "This will bring enormous legal uncertainty for internet companies and therefore probably a loss in sales. The difficult talks with the USA on the Privacy Shield Agreement give an indication of the marathon negotiations Europe will now encounter with England."

Philippe Gruyters, CEO of European Marketing Distribution (EMD): "We remain determined to embrace Asda as a member. Whether within or outside the EU, it makes no difference for our alliance. EMD also has members from outside the EU, such as Norgesgruppen in Norway and Markant Syntrade in Switzerland. Also we have already received from Asda's management a confirmation of their full commitment to EMD."

Ian Wright CBE, Director General at the Food and Drink Federation: "In March we released the results of a members' poll which showed 70 per cent support for Britain to remain in the EU. It's inevitable in the light of these results that the majority of FDF members will regard this as a disappointing result for the food & drink industry. Now FDF will work on behalf of our members and all those across our industry to find a way through the very challenging period that we face."

Josef Sanktjohanser, President of the German Retail Federation (HDE): "Brexit will also undermine confidence in the Single Market idea. I expect there will be a climate of uncertainty combined with more bureaucracy. I also expect that business conditions will worsen for German retailers in Great Britain because of the reintroduction of tariffs and fluctuations in the exchange rate, for example.

With the departure of Great Britain, the EU will also lose an important advocate for the consistent implementation of EU treaties. The shift in the political equilibrium of the EU towards southern and eastern Europe will increase the danger of further trade barriers in these countries."

Hans Van Bylen, CEO Henkel: "I regret this decision because I believe that the EU is much more successful as a Single Market. Had the British stayed it would have been much better for Europe overall.

The immediate effect on our own business is relatively small because we only make around 2 per cent of our annual revenues in the UK. However, we shall have to wait and see what the long-term consequences of Brexit will be for the EU."

Kingfisher: "We recognise and respect the will of the British people in choosing to leave the European Union. Our priority remains delivering our ONE Kingfisher plan. We will be following closely the exit negotiations as they progress.

We ask that the British Government and the European Commission focus on ensuring as smooth a transition as possible for Brexit. It is also critical the British Government does what it can to ensure the continued growth of the UK economy."

Lidl Germany: "We do not wish to comment on the outcome of the referendum. British customers have given us a clear mandate over the past years to provide them with low-price products of the highest quality, and we fully intend to continue fulfilling this mandate. Currently we see no reason to question our strategic plans for the British market."

Lidl UK: "We appreciate and respect that a 'Leave' decision has been made by the British public. However, the process of exiting the EU will take much longer, so it is very much business as usual for us. We have been working hard in the background to plan for this scenario, having established a dedicated taskforce both here in the UK and at our international office, so we are very well prepared...

We will continue to invest in our UK expansion plans for new stores, warehouses, and jobs, working to the highest standards that we have come to demand from ourselves. And we will continue to serve our customers with the best quality products at the best prices that they rightfully expect from us."

Metro Group: "A small majority of the British population has decided to leave the EU. This is very regrettable and represents a crucial event in the development of the EU. The most important thing now, both economically and politically, is to keep a cool head.

The EU must continue to develop and set a new course for the future. In our opinion Brexit hasn't changed the importance and the advantages of the European model for society, culture and business. Everything must now be done for us Europeans to get closer together. Europe isn't just an episode, it's the future."

Eckhard Heuser, Managing Director of the German Federation of the Dairy Industry (MIV): "Although the British vote isn't a good sign for Europe, it certainly doesn't mean that it is the beginning of the end. The UK is and will remain a member of the World Trade Organisation and is therefore obliged to observe the rules of the game. Also food laws will not be changing overnight." (As reported by dpa)

Nestlé:
"We will continue our normal activities."

P&G Germany: "P&G has been active in the UK since the 1930s and we will continue to earn the trust of all people who trust in our brands."

WPP CEO Sir Martin Sorrell: "Very disappointed, but the electorate has spoken. The resulting uncertainty, which will be considerable, will obviously slow decision-making and deter activity. This is not good news, to say the least. The PM's resignation clearly adds to the uncertainty.

However, we must deploy that stiff upper lip and make the best of it. Four of WPP's top ten markets are in western continental Europe, and we must build our presence there even further. It just underlines the importance of implementing our strategy: fast-growth markets (BRICs and Next 11), digital, data – and horizontality, which ironically means getting our people to work together, not apart!"


Related articles in German: Articles by Mike Dawson, Bernd Biehl & Manuela Ohs in Lebensmittel Zeitung, no.s 25 & 26, 24.06.16 viz. 31.06.2016


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