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Inflation isn’t killing food retail. But prices peaking this year might prove to be the bigger challenge.

J Sainsbury Plc on Wednesday confirmed that the food retailers were the big winners this Christmas, with third-quarter same-store sales excluding fuel up 5.9%. They enjoyed a boost from the World Cup and then a run into the holidays whereby consumers were more likely to eat at home given the cost-of-living crisis and rail strikes.

But they were also helped by rising food prices. Sainsbury said inflation in its shopping basket was running well below the 14.4% reported by data provider Kantar for December, as it concentrated on keeping prices low for customers. Even so, making everything from coffee to cereals more expensive inflates the value of supermarkets’ same-store sales. This is what’s happening at Sainsbury, and will likely be evident at Tesco Plc and Marks and Spencer Group Plc when they update on trading on Thursday.

Of course, this isn’t the whole story. The amount of food that consumers are buying is actually falling — although Sainsbury said it was outperforming rivals on this measure — as they seek to manage inflation by putting less in their basket and trading down on brand names. Food retailers’ costs, particularly energy and wages, are also escalating, though there is a good chance grocery inflation is outpacing these rises.

Indeed, Sainsbury said on Wednesday that underlying pre-tax profit in the year to March would be toward the upper end of its £630 million ($765 million) to £690 million range, although this will still be below the £730 million generated in the year to March 2022. It also expects free cashflow from its retail operation of about £600 million, up from its previous guidance of at least £500 million.

This state of affairs might not last much longer. Although food prices remain high, they have started to peak, with the rate of grocery inflation dropping for the past two months, according to Kantar.

And in a sign that consumer goods groups may pass fewer hikes through to retailers this year, US food maker Conagra Brands Inc. said the price rises it implemented had caught up with the inflation it was having to bear in its own costs. If more manufacturers experience this, it may bode well for inflation going forward, as retailers will be under pressure to pass any easing onto customers.

One of the first signs that prices have peaked will be special offers returning to supermarket shelves, as suppliers seek to bolster their sales volumes. Sainsbury said it was hopeful inflation would come down by the middle of 2023.

But when prices aren’t rising as much, life gets tricky for food retailers. In a deflationary environment, they have to sell more loaves of bread or tins of beans to achieve the same value of sales. And if their own costs, such as wages, are continuing to rise, this squeezes profit.

When this happens, the grocers need a weaker player to steal share from. Right now, this looks like Wm Morrison Supermarkets Ltd, which in 2021 agreed to a £7 billion takeover by private equity group Clayton, Dubilier & Rice LLC.

The Bradford-based grocer has been lagging rivals over recent months, after not having cheap enough prices, leaving it at risk from the UK arms of the German discounters Aldi and Lidl. Its manufacturing business also becomes less efficient when the amount of food it makes — and sells — falls. Morrison has seen some green shoots, but it must continue to recover to avoid becoming prey to rivals. Asda initially struggled after the Issa Brothers and TDR Capital acquired a majority stake two years ago, but its performance has improved recently. Privately held Waitrose has also been underperforming.

There are a couple of bright spots. For a start, food prices easing should lift some of the pressure off of consumers. This will not only encourage them to fill their baskets with the things they need, but leave them with a little more for the things they want, such as clothing and home furnishings at Sainsbury’s Argos division.

Even so, Sainsbury shares fell as much as 3.3% on Wednesday morning before recovering slightly.  Investors are right to be cautious. Christmas 2022 was a cracker for the food retailers. Next year’s festive season could be very different.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Andrea Felsted is a Bloomberg Opinion columnist covering consumer goods and the retail industry. Previously, she was a reporter for the Financial Times.

More stories like this are available on bloomberg.com/opinion

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