Fitch Ratings says in a special report that despite rationalisation of their international portfolios, European food retailers' expansion strategy will continue to put pressure on their financial flexibility and ratings. In part, this is due to the increased level of capital investment dedicated to develop overseas activities.

"We are seeing a rationalisation of European food retailers' international portfolios where exiting a non-profitable country is no longer a taboo subject," said Johnny Da Silva, Director in Fitch's European Retail team. "Further M&A in overseas portfolios can be expected this year as shareholders are putting pressure on food retailers to grow or to extract value either by increasing share buybacks or realising value from their real estate. However, companies still need funds to finance their international expansion."

The overseas expansion of food retailers is increasingly becoming a necessity. This is due to the saturation of their core home market, which is characterised by fierce price competition, every-day-low-price strategies and the development of private label, services and promotional activities to compete against hard-discounters. In some countries, regulatory constraints are also limiting local expansion or putting pressure on the relationship between suppliers and retailers. All these are leading to the search of new 'Eldorados', such as China, Russia or India.

However, past experience shows that investing overseas does not equate to instant profits. In some eastern European countries, overseas food retailers' margins still remain lower than those of their core market.

In Fitch's opinion the main reasons for failures overseas include an under-estimation of the country risk, a lack of understanding of the local market dynamics and operational risks. Another challenge stems from the increase of real estate prices and/or rents, particularly for prime retail locations in some emerging markets.

A key success factor for retailers is gaining immediate market share and being able to financially sustain their position. Being able to develop a multi-format strategy is also a requirement given each market's own characteristics in terms of consumer preferences and consumption.

In reviewing most of the main European food retailers with overseas activities, including Ahold, Auchan, Carrefour, Casino and Tesco, Fitch notes that while international expansion benefits diversification, it may take many years for financial returns to materialise.