Fitch expects SL’s modern grocery retail sector to expand in mid-teen digits

• Hypermarkets in urban areas to make gains
• Credit profiles of 3 largest industry players to remain stable
• Large players to deleverage after 2-3-year period
• Possible risks from changes to taxation and price ceilings of goods

Sri Lanka’s modern grocery retail industry is expected to grow in the mid-teen digits over the medium term due to urbanization and increasing per capita income, according to a report by Fitch Ratings.

“Fitch Ratings expects the modern grocery retail sector in Sri Lanka to expand in the mid-teens in the medium term, supported by aggressive expansion and growth in same-store sales. The increasing per capita income and rising urbanisation should make modern grocery retail more affordable and accessible to a larger portion of the population,” the report said.

Fitch said that there is greater potential for growth in the sector since Sri Lanka’s supermarket penetration is still around 15 percent compared to 30 percent for regional peers with similar social and economic characteristics. 

Cargills Food City, Keells Super and Arpico, the three largest supermarket and hypermarket chains, constitute more than 80 percent of modern grocery retail in Sri Lanka, according to Fitch.

“We do not expect the established players to aggressively expand outside of the Western Province in the near term but provinces such as North Central, North Western and Uva provide strong growth potential as they are supported by high per capita income growth and low supermarket penetration,” Fitch said.

It noted that the industry growth in the Western Province would stagnate in the medium term, especially for the companies that focus on fast-moving consumer goods (FMCG) products, as demand for such products tends to be inelastic.

However, companies focusing on hypermarkets with extensive product offerings will make gains in urban areas, Fitch said. 

The ratings agency said that the competitive prices offered by the modern grocery retail stores by sourcing products at lower prices due to the larger scale and the sale of FMCG products, which have maximum retail prices, are making people gradually prioritize convenience and quality of products.

Fitch said that since each new store becomes cash positive in around two years, the leverage in the three largest retailers to expand their operations should reduce substantially after two to three years’ time, while these players are also supported by large, diversified parent companies with strong access to funding.

“Fitch expects the credit profiles of the three largest operators of modern grocery retail chains in Sri Lanka to remain stable in the medium term despite high capex (capital expenditure).”

The ratings agency noted that competition in the sector would not change much, since Cargills Food City, Keells Super and Arpico have strong supply chains and have invested in transportation and warehousing, which would deter new entrants.

“The incumbents have secured a mix of owned and leased properties in prime locations in main cities that would be difficult for a new player to replicate at a time when property prices and rents are rising,” Fitch added.

It said that the regulatory risks stemming from the changes to taxes and price ceilings will affect modern grocery retailers, with even slight changes to taxation expected to affect the companies’ profitability, while price ceilings will only have short-term negligible effects on these retailers.

Meanwhile, Fitch said that the Sri Lankan modern grocery retailers have the infrastructure required to expand online sales and the customers are seeking such convenience and are using credit cards.

However, it noted that the modern grocery retailers will benefit from online sales only in the long-term because the delivery costs would likely to remain high compared to the average basket-size over the next three to four years.