Autumn Statement 2016: Inflation
UK grocers upping their game even as German discounters expand market share. Neil Hall/Reuters

UK grocers are mounting a spirited defence against continuing market share gains being made by German discounters, having boosted their performance and credit quality in 2017, a trend that looks set to continue over the next 12-18 months, according to Moody's.

That said, the ratings agency, noted in a note to its clients that Aldi and Lidl will continue to win market share, curbing UK grocers' revenue growth.

Overall, Moody's expects Aldi and Lidl's combined market share to reach 15% in the next three years, up from 12%, as noted by Kantar Worldpanel. Each 1.0% of market share represents approximately £1.2bn in annual revenue.

Most of the ongoing revenue gains by the discounters will come at the expense of the "Big Four" of Tesco, Sainsbury's, Asda and Morrisons, though it is unclear to what extent inflation and population growth will soften the hit to revenue and how the loss of market share will be spread out, Moody's opined.

Increased competition means that UK grocery retailers' margins are unlikely to return to the 6.0% levels of 2013 and earlier. However, Tesco UK's and Morrisons' margins have begun to recover from the respective 1.1% and 2.1% lows in fiscal 2015 and 2016.

Moody's expects "continued progress" towards 2.5%-3.0% in 2018, provided that the economic environment does not "weaken significantly."

Development of fresh revenue streams will help support UK grocers' credit quality over time. To this end, Sainsbury's has acquired Home Retail Group; Tesco plans to merge with wholesaler Booker Group; and Morrisons is developing its online capabilities and a number of separate wholesale deals.

"Asda is the only large grocer that has not made significant strides to change the scope of its offering so far. Its focus on large out of town units means that it remains most exposed to market share erosion," the agency said.

Moody's rates Morrisons as Baa3 (positive), Tesco as Ba1 (stable), Ocado Group as Ba3 (stable) and Iceland as B2 (stable).