Fitch anticipates European food retailers to maintain their financial profiles although free cashflow generation is expected to be constrained by demands from high levels of capital expenditure (stores openings, refurbishments). Food retailers should continue to develop their private labels and non-food products to increase volume. A focus on cost savings and supply chain remains a key priority to improve working capital and compensate for increased wages, rents and utility costs. Some cross-border M&A activities could occur due to the reorganisation of some players' international activities (Casino, Carrefour, Ahold), leading to both disposals and acquisitions of assets.
Competition amongst UK supermarkets is expected to intensify, competing neck-to-neck for valuable domestic market share often by stretching their brand to respective private labels, investing in quality, while keeping an eye on prices and increasing non-food offerings. The composition of sales will be increasingly blurred by an expansion in non-food sales as supermarkets and even Marks & Spencer are now selling electrical goods including flat-screen TVs. In Fitch's view, M&A or LBO activities are unlikely given competition concerns. The Competition Commission enquiry into the UK grocery market is due to close in early 2007. Discretionary non-food sub-sectors, particularly consumer electronics will face testing times especially when the TV upgrade cycle starts to abate and in the absence of major sports events such as the World Cup in 2006. The UK Do-It-Yourself sector remains under pressure with little visibility of improvement in the short-term.
The hotel industry, which is reaching its cyclical peak, is expected to spend its cash flows on development capital expenditure, notably in emerging markets. It is likely to take advantage of high asset prices and reduce the business's asset intensity either through sale & variable leaseback or sale & manageback transactions. Brewing is likely to remain under pressure in mature markets, therefore further investments or M&A activity are expected in emerging markets to seek growth. Market conditions are more favourable for spirits companies, especially in the US. The process of consolidation of the industry is still ongoing. The possible sale of Absolut by the Swedish State could constitute the M&A highlight of the year.
The outlook for the European tobacco industry is only cautiously optimistic despite the high stability of its cash generation and the abatement of litigation concerns. Challenges to product demand such as tax increases and smoking bans, as well as a more competitive trading environment, highlight the relative weakness of certain players. The recent cash offer for Gallaher by Japan Tobacco could start another round of consolidation.
For 2007, Fitch expects rated European pharmaceutical players to maintain healthy credit profiles, mainly due to their well-diversified product portfolios with a relatively low percentage of sales at risk through patent expiries. Cost-containment policies and a tough generics environment are, however, likely to put pressure on profit margins. This should, however, be largely mitigated by cost-cutting measures and efficiency initiatives.
Food manufacturers remain split between those that are able to withstand margin pressure from raw material prices and retailers, thanks to the pricing power of their brands and cost-cutting, and those that cannot. Due to the phasing of future contracts, benefits from the recent reduction of commodity prices will not be felt immediately in 2007. Ratings could be affected by more shareholder-friendly financial policies.
