Aisle be back

Supermarkets have long provided a strong flow of work for the construction industry, but in recent years there has been something of a slump. In 2000, supermarket chain J Sainsbury dished out 39 contracts worth a combined £356m, making it second to the Home Office as the industry's most valuable client. In 2003, however, it awarded a mere 17 contracts worth about £100m. The decline is partly explained by the fact that Sainsbury's refurbished most of its estate in the previous two years. A heavily government regulated planning system has also affected the number of stores that supermarkets have been able to build.

Now it looks as though changes within the sector are about to trigger a fresh surge in demand for construction services. One factor is the change in the commercial balance of power between the largest firms. Sainsbury's has lost ground to Tesco and analysts predict it will be overtaken by Asda in the next 12 months. Richard Ratner, a retail analyst at stockbroker Seymour Pierce, says: "We're going to see three major powers – Tesco, Morrisons and Asda – emerge in 2004, with a struggling Sainsbury's."

The new hegemons will try to consolidate their successes by upgrading their existing stores and seeking to build more. Tesco is planning to raise £1.7bn, much of which will be used for construction work. Morrisons' £3bn bid for Safeway has been cleared by the Department for Trade and Industry and is expected to go through in March. This will lead to a swath of refurbishment as a result of rebranding alone. Meanwhile, Sainsbury's is looking to improve its financial performance by installing mini-markets in 100 Shell forecourts.

If you want to know what this means in pounds and pence, consider the following costs. A typical modern store costs about £4m to build – Mace finished a Safeway in Stratford-upon-Avon for £5m last month. The contract value is about £10m for a hypermarket, and a refurbishment is somewhere in the region of £200,000.

Morrisons' acquisition of Safeway will be characterised by full-scale refurbishment of its major stores and some less dramatic work on the medium-sized shops. Even the 140 smaller supermarkets will be subjected to refits as new product lines are introduced. A source at Safeway says that the group cannot yet put an exact figure on the value of the expected contracts.

If the Safeway deal goes through, all the rebranding means morrisons will bring a lot of work to the market

Retail expert

But construction companies are excited about the prospects: "If the Safeway deal goes through, all the rebranding and reformatting means that Morrisons will be taking a lot of work to the market," says one contractor's head of retail.

It seems likely that much of Safeway's refurbishment work will appeal to high-end interiors specialists. Steve Gotham, a retail analyst at Verdict, expects Morrisons to introduce more customer-friendly layouts: "Morrisons has a reputation for good store designs. They are maybe not as eye-catching as the external structures of Sainsbury or Waitrose, but nonetheless they generally produce quality internal designs."

Morrisons' purchase of Safeway has not been driven purely by its thirst for market share, although the merger will give it 552 UK stores. The government has a policy of protecting smaller traditional shops, and has used the planning system to discourage the building of hypermarkets. By acquiring Safeway, Morrison sidesteps the costly and time-consuming planning process. Chris Slamon, a director at architect Chetwood Associates, has worked for Sainsbury's in the past. He says that much of the upcoming work in the sector will be refurbishment of existing stores: "Certainly it's not the economics of the building industry which is preventing the construction of new supermarkets, it's the tight planning regulations," he says.

The supermarket industry is also restricted by the competition authorities. "It must be the most overregulated industry in the country, besides water and the railways. In fact, it is almost treated as a nationalised industry," says an industry expert. The Safeway deal was allowed to go ahead on the condition that Morrisons sold 23 stores on. Tesco is favourite to snap up those branches.

If the Safeway deal goes through, all the rebranding means morrisons will bring a lot of work to the market

Retail expert

If it does, Tesco will refurbish and rebrand, but that will make up only a small part of the chain's construction programme. The supermarket has raised £773m of its £1.7bn target from a share issue. Sources at Tesco suggest that it may get the balance by selling and leasing back part of its property portfolio. The source says: "It is an option that is being looked at. An announcement will be made later this year. It reflects the fact that we're not complacent – it is a very competitive market."

Tesco intends to change the layouts of its existing stores, so that it can incorporate more non-food items, which now make up a hefty chunk of its turnover. It is also planning to increase the number of its smaller Express stores and expand overseas. At present, it has 189 hypermarkets in 10 countries.

The top end of the supermarket sector is clearly about to provide strong cash flow to contractors in the coming years, but the operators of smaller supermarket formats are feeling the pinch. Costcutter, which has grown from three stores 16 years ago to 1200 today, is one such operator. Stuart Broadhurst, the firm's property and estates director, anticipates that the company's store base will increase no more than 11.5% in 2004: "The market conditions are tougher than they were a year ago. The target is usually to grow the number of stores 15% a year."

A slowdown among food operators such as Costcutter is unlikely to have an impact on the larger contractors, but smaller firms may suffer. Costcutter usually employs regional contractors: "We don't like using national companies. It's very easy to pick the phone up to speak to just one contractor [to work on the stores], but there's a cost for that convenience," says Broadhurst.