While trumpeting another successful year, Aldi’s annual results showed steep downturns in both operating and pre-tax profits, as it slashed prices amid ferocious competition. Retail Week looks at how low Aldi can afford to go on margins, and what that means for the wider grocery industry. 

Unveiling results for the 52 weeks to December 31, Aldi UK and Ireland chief executive Giles Hurley was in celebratory mood. The figures, he said, showed that the value giant had achieved yet another “record year”, disrupting the UK grocery sector and winning customers, sales and market share from rivals.

An 11% increase in sales to more than £11.3bn, and a 5% increase in customer numbers to in excess of 16.6 million, were certainly worth crowing about. But the retailer also reported some eyewatering slumps in its operating and pre-tax profit columns – the former was down 26% to £197.9m and the latter fell 18% to £182.2m.

Hurley was keen to play down the decline in earnings. He said 2018 was a “year of growth and investment, and the growth figures speak for themselves”.

Investment was primarily focused on “reducing prices and putting money back in customers’ pockets”. Additionally, Hurley pointed out, there had been investment in the branch network. “We opened on average a store every week last year,” he said.

However, the consequence, as broker Barclays pointed out in a note, was that Aldi found itself operating on a razor-thin 1.75% EBIT margin last year. The note also said “the lower Aldi’s UK margin falls, the less oxygen is arguably available to fight against the big four”.

Big four fight back

For Shore Capital head of research Clive Black, that figure represents an “admission” that price investments by the big four have made life harder for Aldi.

“For years Aldi, and Lidl for that matter, had basically a free shot at the UK grocery market. In that respect [price point], life was very easy for them. They went through the British grocery scene like a dose of the salts.

“That started to change four or five years ago, particularly driven by Tesco and Morrisons at the time. They started to understand what Aldi was about, and react on a number of fronts, including price. The reality is the material reduction of Aldi’s margins now: 1.75% margin shows the real cost of Aldi competing.”

Black observes that just a few years ago, Aldi was delivering margins in excess of 5% in the UK. “The cost of competing has meant that has come down considerably,” he says.

Global insights director at TCC Global, Bryan Roberts, also thinks Aldi is beginning to feel the pinch, as rivals push back.

“The issue it’s faced is that, in order to succeed, it needed to build in a bit more complexity in its model in terms of range and merchandising. It’s also had to up its game in terms of service,” he says.

Roberts says that spending more money on expanding its offer, staff service and new formats, mean Aldi’s thin operating margins are “understandable at the moment”. However, he believes Aldi will likely seek “to regain some of those efficiencies it may have diluted in order to succeed in middle England” in the long run.

He also points out that, given price has always been Aldi’s unique selling point, it is willing to “drive prices incredibly low in key battleground products”, such as fresh produce and proteins, where it can “afford to take a hit while tweaking prices in the background on other items”. 

Long-term focus

Despite the razor-thin margins and downturn in profits, Hurley remains bullish, emphasising that Aldi’s ownership structure allows it to focus on the long term. Part of that is what Hurley described as “an unbreakable contract with customers” to be the cheapest in the market, indicating that margins will not be massaged upwards for their own sake. 

He maintains: “We’re not like other supermarkets. We have a unique model. We have a critical advantage as well, which is private ownership, which means we can run the business for the long term and don’t have to answer to shareholders. We’re not, and never have been, focused on short-term profits. Our focus is on growth, sales, stores and customer numbers.”

To that end, Aldi also made much of its plans to expand its UK estate, from 840 shops at present to 1,200 by the end of 2022, including plans to more than double the number of branches in London to 100.

Retail analyst at GlobalData, Thomas Brereton, says the retailer’s expansion plans, particularly within the M25, could end up being risky: “Saying it wants to have 1,200 stores open by 2025 – it will keep them growing well above the market for the next four or five years, on store openings alone, but it might be left with a big store network. What it has undoubtedly works now, but they’ve pledged themselves to this strategy for the foreseeable future, even though things are always changing.”

Brereton also says that the cost of expanding in and around the capital may further eat into Aldi’s operating margins.

“To offset the expected cost of rolling out in London, it can’t really afford to have stores making losses in other parts of the country as well. It’s kind of a balancing act, and it will have to be careful.” 

Earnings fall just a blip?

While Shore Capital’s Black says Aldi’s parent company won’t be “rationing the apple strudel at the Christmas lunch this year”, it will be concerned where the UK business ends up “bottoming out”.

He says: “Aldi is two-thirds of the way through its UK journey. In that respect, having opened over 840 of a desired 1,200 stores, I’d say it’s been through the zenith of its influence on the UK market. It’s not going anywhere, but the fact the margins and the fact the operating profits are down 26% tells you that maybe the UK is no longer such easy meat.” 

Black adds that the big four supermarkets are beginning to “respond intelligently” to the problems posed by discounters such as Aldi. Having addressed their own pricing, he believes the big four can then begin “extolling the points of difference where Aldi and Lidl can’t compete”, such as on proprietary brands and service. 

Faced by competition that is improving, Aldi has decided to go against the UK grocery grain – expanding its store estate, while refusing to bend when it comes to price. What long-term effect that will have on profitability remains to be seen, but for Hurley, the last financial year’s profit fall was nothing more than a blip. 

“The last year has brought an unprecedented and unrivalled growth in our format and our investments and infrastructure in our supply chain,” he states. “No other supermarket is doing what we’re doing at our scale – our plans aren’t going to change.”

No doubt Hurley hopes margins won’t come under any further pressure, but if they do, it seems he and Aldi are willing to take the pain in the expectation of ultimate gain.