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Disclosures & Disclaimer

This report must be read with the disclosures and the analyst certifications in

the Disclosure appendix, and with the Disclaimer, which forms part of it.

Issuer of report: HSBC Bank plc

View HSBC Global Research at:

https://www.research.hsbc.com

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March – 12

April

If you value our serviceand insight, please vote

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Vote in Extel 2019

THIS CONTENT MAY NOT BE DISTRIBUTED TO THE PEOPLE'S REPUBLIC OF CHINA (THE "PRC")

(EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAO)



Food retail has various life stages and these drive industry

structure & strategies. We examine these in detail inside.



Profits, returns & cash flow evolve through different life

stages. The winning strategy depends on the life stage.



Understanding the relevant life stage for each country helps

identify winning strategies, retailers and investments.

The Life Stages of Food Retail. This is the second theme in our series on Retail

Economics. In this issue we study the life stages of food retail, from the birth of organised

retail through to maturity, the discount era and the new age. As with our previous theme,

the findings transcend time and geography and we believe the life stages highlight the

natural evolution of the 4 principles of food retail economics. We examined these

principles in detail in Global Retail Digest: Issue 1. As a reminder they are:



Demand is inelastic at the industry level



Demand is highly elastic at the company level



Retailers have high operational gearing



Industry has high economies of scale (relative to profits)

A crunch time is when the industry passes through the Space Race. If expansion

continues unabated, we end up in a capital war with overcapacity as the UK suffered

c2010. This leads to an inevitable fall in profits and a collapse in returns. It can expedite

discounter entry. On the other hand if the industry is well managed with a strong leader,

these stages are not inevitable. Within the report we look at different geographies and

highlight which life stage each is at. Lessons learnt in one country can be applied to

others. We also remind readers of the Prisoner’s Dilemma which explains how rational

decisions by individual firms can lead to irrational outcomes for the collective.

Key Reports: The Global Retail Team has published a large number of important reports

recently, several of which are highly applicable to readers in each region. See page 28 for

details, but in particular we would highlight:



Lease accounting: IFRS 16: the biggest changes in over 30 years, 19-Feb



Poland food retail: Proximity formats working for Dino, 21-Mar



LatAm food retail: Protecting groceries from being clicked away, Mar-19



The curious case of disappearing CEOs, 04-Mar

Emerging Market-Developed Market Bridge. Also inside is our Global Retail Diary and

Global Comp Sheet. We also include important ESG and other reports that have

important implications for retail.

Extel is very important to us this year. If you think this report is helpful, please show

your appreciation by voting for HSBC Retail. The link is here.

8 April 2019

David McCarthy*

Global Head of Consumer Retail Research

HSBC Bank plc

david1.mccarthy@hsbcib.com

+44 20 7992 1326

Ravi Jain

Senior Analyst, LatAm Retail

HSBC Securities (USA) Inc.

ravijain@us.hsbc.com

+1 212 525 3442

Jeanine Womersley*, CFA

Analyst, South African Retail

HSBC Securities (South Africa) (Pty) Ltd

jeanine.womersley@za.hsbc.com

+27 21 795 0779

Nigel Kiernan*

Director, ASEAN Consumer Analyst

The Hongkong and Shanghai Banking Corporation

Limited, Singapore Branch

nigel.kiernan@hsbc.com.sg

+65 6658 0809

Bulent Yurdagul*

Head of EEMEA Consumer Research

HSBC Yatirim Menkul Degerler A.S.

bulentyurdagul@hsbc.com.tr

+90 212 376 46 12

Karen Choi*

Head of Consumer and Retail Research, Asia Pacific

The Hongkong and Shanghai Banking Corporation

Limited, Seoul Securities Branch

karen.choi@kr.hsbc.com

+82 2 3706 8781

Paul Rossington*

Analyst

HSBC Bank plc

paul.rossington@hsbcib.com

+44 20 7991 6734

Andrew Porteous*, CFA

European Retail Analyst

HSBC Bank plc

andrew.porteous@hsbc.com

+44 20 7992 4647

* Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is

not registered/ qualified pursuant to FINRA regulations

The Life Stages of Food Retail

Equities

Consumer Retail

Global

Global Retail Digest 2: Retail Economics Part II

Equities

●

Consumer Retail

8 April 2019

The four economic principles of food retail

To understand the evolution of food retail, it is important to have a firm grasp of the four underlying

economic principles that characterise the sector. They were covered in detail in the previous issue of

GRD (see Food retailing: A natural monopoly, 24-Jan). In summary, they are:



Inelastic demand at the industry level: The total amount of calories consumed each year

does not vary much and is relatively insensitive to changes in industry pricing or consumer

incomes. This is perhaps best evidenced by looking at food expenditure as a percentage of

total consumer expenditure. This ratio is in decline across all the markets we consider,

driven by two key factors. Food is an inelastic necessity – the richer people get the lower

the proportion of income they have to spend on food. But another factor is related to the life

stages of food. The more an economy passes through the life stages, so do efficiencies and

competition lower real prices, meaning the same items can be bought for less in real terms.



Elastic demand at the company level: Consumers will switch from one retailer to another for

relatively small changes in price but tend not to consume more calories overall. For one

company to win sales, another has to lose sales; it is a zero sum game. (NB this sensitivity is

one reason why we think the CMA in the UK is right to use a low value for its GUPPI (Gross

upward pricing pressure index) analysis into the proposed takeover of Asda by Sainsbury).



High operational gearing: Profits are highly sensitive to small changes in sales. Typically we

expect a 3 to 1 ratio (i.e. a 1% change in sales impacts profits by 3% without any mitigating

actions). This is because food retailing has a high proportion of fixed costs and is a low margin

industry. Please see the Global Retail Monthly 1 for more details.



Economies of scale: These should be measured relative to profits, not to sales, and are

very important in a low margin industry. In the UK, we believe that Tesco’s economies of

scale advantage over Sainsbury is around twice Sainsbury’s entire profit level. That

Sainsbury can identify GBP1.6bn of synergies from its proposed takeover of ASDA (c3% of

combined businesses) without fully integrating the businesses and running two chains with

their own head offices and logistics networks, shows the extent of Sainsbury’s cost

structure disadvantage versus Tesco.

The combined impact of these factors mean that food retailing evolves through a number of

different life stages. Each stage requires a different strategy (we will examine winning strategies in

the next issue of GRD) and each stage has different characteristics regarding profits, cash flow and

valuations. We argue in this report that different life stages require different valuation metrics.

We identify a total of eight life stages and we discuss each one in turn. However, not all life

stages are inevitable; the industry comes to a critical juncture as it exits the Space Race stage.

If the industry carefully manages itself, it can move to a more positive New Age. If it manages

itself badly, it can lead to the Discounter age with severe consequences for long term profits,

returns and cash flows. Ending up in a difficult life stage can be the result of rational and logical

decisions, as we demonstrate.

Rational decisions can lead to irrational outcomes: As the ‘Prisoners Dilemma’ demonstrates,

rational decisions by individual companies can lead to an irrational outcome for the collective. Please

see the following text box on page 26 for a description of the Prisoners Dilemma and its application to

space growth. We will now go on to examine the eight key life stages.

The four economic principles

of food retailing do not

change

“If we are to grow, it has to be

at someone else’s expense.”

So said the founder of Tesco

over 50 years ago, and it holds

true for all food retailers today

Food Retail Economics drives

a series of predictable life

stages

Equities

●

Consumer Retail

8 April 2019

1: Informal Retail – Wholesale Dominates

The first life stage is the starting point of evolution. It is typically characterised by lots of

small, independent retailers, typically owner-managed. Food markets and wet markets are a

common feature, with wholesaling playing the major part in food distribution.

There is no retail branding, no own label and minimal brand loyalty. In fact, there is often little

FMCG brand availability. Retail standards are often poor and there is no retailing and logistics

infra-structure.

Markets such as India are at this stage currently. Cash and Carry is often the best way for

companies to access such markets but over time this channel will grow slower than the

consolidating and expanding retailers. Key features and characteristics include:



Cash and carry enables small retailers to start building infra-structure and retail assets.

These can later be re-purposed to service more organised and advanced retail formats

and offerings;



Wholesale operators often benefit from asset/property value appreciation as

emerging cities grow over time;



C&C formats allow branded manufacturers to start accessing disparate and small

retailers, building manufacturers brand awareness and penetration;



The development over time of wholesaler private brands;



Focus on high volume and often commoditised ranges

C&C operators need to be aware of over developing their offers and thereby leaving

themselves vulnerable to the evolution of the retail market. As retailers grow and enter

subsequent life stages, the Wholesale/C&C market matures. They need to avoid the lure of

growth and over expansion. Booker, now owned by Tesco, entered the Indian market with many

of these features in mind, seeing the opportunity to service a fragmented market, the

opportunity to develop a franchised chain and the possibility of long term appreciation in their

property assets.

2: The Emergence of Modern Retail

Over time, the better retail entrepreneurs emerge and start to build their businesses, adding

new outlets and purchasing other smaller competitors. Characteristics of this life stage include:



Lots of small and medium sized chains, with several winning formats.



These retailers are usually regional players, building on localised economies of scale



Retailers are still family owned and managed with a high degree of entrepreneurship



This is the start of retail branding with associated features of standardisation, developing

infra-structure, FMCG brands more widely available with very limited private label.



Profits and margins improve through improved efficiencies and early stage economies of

scale. Consumers tend to get an improved offer compared to the previous stage. There are

improvements in prices, availability, quality, retail standards etc. Consumer’s benefit and

industry profitability improves through productivity.

This tends to be an exciting time for the industry with lots of winners and improvements in

price/quality/range for consumers. But even the largest operators still have small market shares

and it remains a very fragmented industry.

Wholesale dominates the first

life stage but has a limited

time in the sun

As modern retail emerges, so

does Wholesaling become

less important

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