Some stockbrokers are upgrading shares in supermarket retailers Coles Group (ASX: COL), Woolworths (ASX: WOW) and Metcash (ASX: MTS) as panicked Australians hoard essentials.

But rising costs will limit supermarkets’ gains, with a warning too that the benefits may only be short-term.

This increase in supermarket sales is backed by data from Australian Bureau of Statistics, which has brought forward its measurement of retail sales to provide more up-to-date information on the economic impact of coronavirus.

According to the ABS, the seasonally adjusted estimate for retail sales in February rose 0.4 per cent following falls in both December 2019 and January 2020. The rise in seasonally adjusted terms in February 2020 was largely driven by food retailing, with supermarkets recording big increases in demand.

“The preliminary figures indicate a rise in food will be slightly offset by falls in industries such as clothing, footwear and personal accessories and other retailing. While some businesses (for example, those that rely on tourism) reported that coronavirus negatively impacted turnover, a range of other businesses saw limited impacts from coronavirus in February,” the ABS said.

coles shopfront

As labour costs rise so too do the costs of transport and logistics as supermarkets scramble to get stock shelves

The move comes as the competition watchdog allows supermarket rivals to coordinate supply and logistics so vulnerable consumers aren't left empty handed amid the panic-buying.

The ACCC announced Tuesday that Coles, Woolworths, Aldi, IGA supplier Metcash and others would be given temporary permission to cooperate when liaising with manufacturers, suppliers, and transport and logistics providers to keep their shelves adequately stocked during the pandemic.

Competition law usually prohibits certain market conduct between supermarkets and the new agreement essentially provides temporary protection from prosecution and during this "unprecedented demand for groceries".

Separate data from NAB’s Cashless retail sales index for February 2020 released last week shows that supermarkets and grocery sales jumped 10 per cent year-on-year, up from 5 to 6 per cent growth over the past 12 months.

Spending on food and other supermarket items is expected to surge in March, reflecting massive buying activity by consumers in response to coronavirus.

“Panic-buying has now set in at supermarkets across Australia. While this will boost the headline retail sales figure in March, other retail sectors and consumption spend more generally in areas such as health, education, restaurants and other services – including airlines face massive challenges,” said NAB chief economist Alan Oster.

Dunny paper selling but margins are slim

Morningstar director of equities Johannes Faul says while sales are higher than normal, the profitability of supermarkets may not rise as much as their top-line sales suggest. The margins on the sales of the products being hoarded—pantry items such as rice and pasta, as well as toilet paper—are not as high as they are on premium goods such as organic and health foods.

Moreover, any rise in margins will be limited by the higher cost of these sales for supermarkets. As labour costs rise so too do the costs of transport and logistics as supermarkets scramble to get stock shelves. 

“There is no doubt that the coronavirus has brought forward sales of things like rice, pasta and toilet paper. But there's also a risk that the bringing forward of sales means that sales will be missing down the track,” Faul said.

“The coronavirus is a short-term issue. Things could normalise by the end of this year and maybe we'll have a vaccine next year. Over the long term, the profitability of supermarkets hasn't changed. For a long-term investment, both Coles and Woolworths are one-star rated, which suggests that they are overvalued,” he said.

Faul has a fair value on Woolworths of $27.50, versus its current market price of around $35.00. For Coles, he has a fair value on the stock of $12.50 versus its current market price around $15.50. 

Faul expects Aldi may even increase its market share if there is a recession at the expense of the other two major supermarkets.

New behaviours emerge for short term

Investment bank UBS says the pandemic “will embed new behaviours in consumers, potentially leading to an acceleration in the rate of online penetration (both grocery and fast food) and is likely to see a return to cooking at home, at least in the near term.”  

UBS now forecasts first-quarter supermarket sales will rise by 9.5 per cent in the first quarter from a year earlier and by 6.1 per cent in the second quarter, before moderating to around 5 per cent year-on-year in the third and fourth quarter of 2020. 

But while margins will, increased supply chain and labour costs will limit the expansion, UBS said.

Of the three supermarkets, UBS prefers Woolworths given its perceived  superior management quality and preferred valuation.

“We lift earnings per share (EPS) to 4 to 6 per cent across Coles, Metcash and Woolworths in financial year 2020 to reflect this. Our rating on Coles moves to Neutral (from Sell), Metcash to Buy (from Neutral) and Woolworths to Buy (from Neutral).”

According to Morgan Stanley, these stocks had outperformed the S&P/ASX200 by around 42 per cent (Metcash), 35 per cent (Coles), and 21 per cent (Woolworths) since the market peak on 20 February to 18 March 2020.

“NAB [Cashless retail sales index] commentary notes that spending in supermarkets began to ramp up in response to outbreak in late February, so assuming that the first three weeks of February were running in line with the around 6 per cent trend over the past 12 months, this would suggest spending in the last week of February was up as much as around 20 per cent year-on-year,” said Morgan Stanley.