Valuing Asda at £7.3 billion, Sainsbury’s bid for the supermarket is a big deal in an important sector.
The UK food retail space has historically been quite consolidated, with the Big Four of Tesco, Sainsbury’s, Asda and Morrisons holding onto about 70% market share nationally.
They might hold a decent chunk of the market, but the Big Four haven’t had an easy ride of it over the last decade, with discounters Lidl and Aldi snapping at their heels since the financial crisis.
There have been accounting scandals at Tesco, industry-wise profitability issues, and the irreversible impact of technology on changing consumer habits. The days of weekly trips for a big shop are dwindling, replaced by shorter and more regular convenience trips, not to mention online shopping.
Still, years of rebuilding is starting to feed through into stronger performances across the sector. Tesco and Morrisons were the fastest growing supermarkets of the big four in the first quarter.
Tesco versus Sainsbury’s
Cementing its 27.6% share of the market, Tesco’s sales have grown more than 2% for 12 consecutive quarters – the first time it’s done this since March 2011.
The picture for Sainsbury’s looks less buoyant, as the supermarket struggles to transition away from its focus on promotional sales. The merger will want to piggyback on the growing momentum behind Asda.
The supermarket attracted an extra 309,000 shoppers through its doors in Q1, which helped it achieve sales growth of 2.3% – its best since 2014. Asda’s a hit with more households, with 15.8 million families doing their grocery shop in the first quarter, 500,000 more than Sainsbury’s.
The Sainsbury’s and Asda tie-up could transform the supermarket landscape, with the combined duo bringing an end to Tesco’s monopoly with its 31.4% share of the market.
Still, the market value of the Big Four highlights the gulf between Tesco and its competition. Even joining £7 billion Sainsbury’s and £7.3 billion Asda won’t get the new supermarket close Tesco’s market value of £23 billion. Morrisons is worth £5.5 billion.
Will regulators approve the deal?
This deal is about competition. Whether it’s accepted or not will say a lot about competitive dynamics, and how business and government imagine people will live in the future.
Slashing four big supermarkets down to three will be a significant shift for the food retail landscape, and it’s something that the UK competition authorities will look at closely. Having three players controlling 70% market share might not sit easy for consumers and suppliers.
The pair will need a good defence to get the deal waved through by regulators. Their argument will probably be centred around changing consumer habits, the threat of the rising disruptors, with Aldi and Lidl holding a 12% share of the market.
The two appeal to different customer bases. Where nearly two-thirds of Asda’s sales are generated outside of London and the south east, that’s exactly where Sainsbury’s generates the majority of its sales.
History says it won’t be easy
The last big deal between Morrisons and Safeway was a long and painful process that involved store divestments and a lot of disruption.
Historically, the regulator has cared about local market share. They created local maps for the Morrisons/safeway tie-up, measured by drive times, and looked to see where competition really fell away. Where local choice really disappeared, they forced Morrison- Safeway to sell stores to competitors.
You’d guess something similar will apply this time around – Sainsbury’s and Asda are betting that their store overlap isn’t big enough to upset the deal.
But mergers are notoriously difficult, particularly if the two businesses are large and complex. It might look like a powerplay in some lights, but this deal is being done from a position of weakness. You can see this from the valuation, which is about equal to the value of the land on the balance sheet.
Against a tough backdrop like this, consolidating and cutting costs makes sense – if the regulator lets you.
What does this mean for investments?
Whilst interesting, this news means very little diversified investment portfolios. Food retail is a small part of the global equity universe, which means diversified portfolios should have a small exposure to the sector.
This strategy might not deliver the 20% returns you saw in one morning from Sainsbury’s off the back of this deal, but it would have helped smooth out the negative performance from the struggling sector in the recent past, and should offset fluctuations if the deal doesn’t go to Sainsbury’s plan.