Discount supermarket growth 'slows sharply', UBS upgrades Morrisons

Data gathered by the Swiss bank shows industry store space growth at a 10-year low of 1.2% in the second quarter of 2018, with both Aldi and Lidl slowing their rate of store growth.

With UK grocery sales demand outpacing supply by 2:1, UBS predicts sales densities will be rebuilt over the mid-term and boost margins.

Industry observers had previously predicted that discounters Aldi and Lidl's business model of higher sales densities and lower cost per foot of new space would allow them to profitably add new space ad-infinitum, without requisite improvement in industry margins. "We see little evidence of this," said UBS, pointing to Aldi's EBIT margin falling from 5.1% in 2013 to 2.4% in 2016.

"Discounters are leading the market on price inflation," analysts added, with like-for-like sales now in low single digits and new space is slowing.

Morrisons shares were the main beneficiaries as UBS data shows discounters, especially Aldi, have been the key source of Morrisons' switching losses in recent years. But Aldi store openings have slowed sharply in the first half and LfL's are now only marginally positive.

"As this competitive pressure abates, we believe Morrisons' management is now in a position to allow more of its 'self-help' efficiencies to drop through to margin."

Morrisons has a "superior capital structure" that investors should not ignore in the face of shares trading at a multiple of 18 times future earnings, the Swiss bank's analysts added, suggesting the FTSE 100 grocer is "attractive for more risk averse investors" with a strong balance sheet and a cash generative portfolio, with an 8% free cash flow yield, its distinctive brand re-established and dramatically improved trading under new management.