OREANDA-NEWS. January 19, 2016. European food retailers' ability to combat lacklustre economic conditions and changing consumer spending patterns are the key driver in the sector's credit ratings trend, Fitch Ratings says in a sector peer study.

We believe initiatives to revamp shop formats and improve e-commerce offerings will be a common theme in 2016. Successful strategies that lead to sales and profit growth will be those that meet consumers' continued desire for value for money in terms of low prices, ease of ordering and delivery and high quality service. This trend can be seen in Sainsbury's potential interest in Argos. But profitability from online operations will remain elusive for many retailers and we do not expect the sector to generate a significant EBIT contribution from online activities in the medium term.

One of the most successful responses to the pressures of the last few years has come from Carrefour, which has turned around its core French operations, improved its geographic balance and diversified its store formats. The improved business profile contributed to the group's upgrade to 'BBB+' last year. Conversely, in a UK market that remains fiercely competitive on price, Tesco's turnaround has been harder, partly a legacy of its sizeable exposure to larger formats, but is gaining momentum. This was reflected in positive underlying like-for-like sales growth during the crucial Christmas trading period. The focus of attention is now shifting towards mid-term profitability levels achievable for the retailer supported by increased financial flexibility due to the disposal of its South Korean operations.

The conundrum of what to do with excess space in larger stores contributed to Sainsbury's opening Argos concessions in 10 of its stores, which was followed earlier this month by the announcement that it had made an approach to buy Argos' owner Home Retail Group. Argos' advanced online ordering system and logistics could strengthen Sainsbury's online groceries business, while introducing a click and collect service for Argos orders in Sainsbury's stores would give customers more delivery options and increase footfall in stores. Whilst these plans show that retailers are thinking outside their traditional lines of business to react to evolving shopping habits, there remain execution risks around the compatibility of brands and their customer bases.

Food retailers will continue to innovate in response to online and other forms of competition, yet we do not expect any significant improvement in margins in the medium term. Deleveraging is also likely to be slow over the next couple of years as it will rely on operating turnarounds in core markets. While Casino needs to demonstrate sustained improvement in profitability in France to sustain its rating, we expect a more pronounced deleveraging by 2017 from the recently announced asset divestment of at least EUR2bn.

For more details on the comparison between Fitch-rated issuers in the sector, see "European Food Retail Peer Study" available at www.fitchratings.com or by clicking the link above.