Bottom Line: Hurt in war of nutrition

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The Independent Online
THOSE who feared that Kwik Save would be the real victim of the price war between the big three food retailers will have found ample ammunition in yesterday's interim results.

Grocery prices fell 2 per cent in its first half, are now running 3.5 per cent below last year, and the group warns that deflation will get worse before it gets better. Making sure the customers knew about the cheaper prices pushed the advertising bill up 30 per cent to pounds 5.8m. But it still only managed a 3.2 per cent volume increase in the first half, falling to 1 per cent in the second, for its troubles.

That was enough for the bears and its shares fell 2p to 570p, despite the market's bounce, adding to the 15 per cent underperformance against the - hardly sparkling - food retail sector since the price wars started for real last autumn.

A market position between the no-frills discounters and the big three chains was always going to be uncomfortable, but Kwik Save is clearly prepared to fight. Despite the fall in its prices, it managed to hold the drop in gross margins to just 0.2 percentage points. That is partly due to judicious buying of tobacco and drink ahead of the Budget, but it also suggests that it is managing to persuade suppliers to shoulder a good proportion of the price war pain.

Tight control of costs meant the erosion in the net margin was limited to 0.1 percentage points, leaving them at 3.6 per cent. But that is less than half what the big boys are achieving, so any further falls are likely to be that much more painful. And any further cost savings will be passed back to customers as lower prices.

Kwik Save is pressing ahead with its programme of opening about 80 stores a year. Unlike some of its larger rivals, it can comfortably afford that expansion from its cash flow. And, with the average cost of a freehold site just pounds 1.5m - a tenth of a big-three superstore - its goal of at least a 25 per cent return on capital looks reasonable.

Analysts are expecting about pounds 130m for the full year, putting the shares on a multiple of about 10-20 per cent below the market. That looks cheap but, until the price wars settle, there is unlikely to be much upside.