UK Retail Briefing - May 2019
Analyst Comment – Sainsbury’s and Asda – Where Next?
 
It’s been a busy month for the second and third players in the UK grocery market.

●	The CMA blocked the proposed merger.
●	Sainsbury’s reported its full year figures with particularly disappointing sales in the final quarter.
●	Speculation is rife about Asda’s future.
●	British has offloaded 12 of the stores it bought in a JV with Sainsbury’s.

Swings and roundabouts
Three years ago when Sainsbury’s bid for Argos, it was the top performing supermarket group. But now it is by far the weakest with tales of poor availability and rising prices. Sainsbury’s is still positive about the prospects for the Argos deal, though the relocation of stores into Sainsbury’s concessions has hit sales of general merchandise in the short term.

Too many takeover bids
The Proposed Asda deal would have been another matter altogether. It’s easy to see why the Competition Commission blocked the deal (especially with hindsight), less easy to see why Sainsbury’s was so confident that it would go through. In fact, Sainsbury’s spent £46m on the deal which it had to write off in the recent final results.

We were against the deal from the start, not so much from the competitive angle which was why the CMA blocked it, but from the point of view of Sainsbury’s and Asda themselves. Two aspects worried us:

●	The businesses were so completely different in their market positioning that any attempt to bring them closer together, through common buying, or whatever, could end up damaging both.
●	The distraction of management time from running the Sainsbury’s business would leave the business rudderless for too long.

We think that it’s the second factor which is behind the recent poor performance of Sainsbury’s. The reasons for the recent poor performance appear to be just that lack of attention as matters have been allowed to drift downwards.

Asda getting its act back together
On the other hand, Asda has been able to concentrate on running its own business. Integrating with Sainsbury’s was a problem for later, if it ever happened. And after a few years of very poor performance, Asda has restored some momentum to its business and it is now among the best performers. At least it was, until the mildly disappointing first quarter figures recently reported. But it is still comfortably outperforming Sainsbury’s.

But where next for Asda?
The motivation behind the deal in the first place was surely that WalMart wanted to sell. It was its only remaining business in Europe and its international ambitions are clearly focussed on the developing world. Sainsbury’s must have thought that it would rather have control of Asda than see it in anyone else’s hands. But now that the deal has been blocked, there’s no realistic possibility of it being bought by any other major UK food retailer. In fact, given the state of the UK food retailing market at the moment, it is hard to see any other foreign superstore operator wanting to enter the market either. 

As soon as the CMA made its announcement speculation was rife. Perhaps KKR would put together a bid, or any one of a number of other private equity businesses. But nothing has happened, so now we are left with the only other viable option – that Asda might be refloated on the stock exchange. And WalMart also seems to accept that that is the only viable option.

An IPO looks to be the only option
It’s 20 years (July 1999) since WalMart bought Asda after a hotly contested bidding war with Kingfisher. It paid £6.7 billion for it at the time. But in those days food retailing was still a growth business. Since then the scope for opening new stores has dwindled and the rebirth of the hard discounters has fundamentally changed the competitive situation.

The major food retailers are fighting a rearguard battle to try to hold on to market share while bringing their price levels down to be competitive with the hard discounters. Asda claims to have made further price investments in the first quarter of 2019. The market leaders are now mature businesses and the prospects for growth above the rate of inflation are severely limited.

But Asda is still profitable. In the year to December 2017 (2018 figures have not yet been published) it reported after tax profits of £666 million, so, assuming that profits didn’t fall in 2018, it should be able to command a price of at least £8 billion. Walmart would have hoped to do better with a private sale, but a least a flotation would allow it to sell Asda for more than it paid.

Reinforcing the status quo
Sainsbury’s has paid £46m to establish that the CMA will not allow any further concentration in the food retailing sector. In the longer term that could change, but it is hard to see there being so much change in, say 10 years, for the CMA to change its mind.

But it would be foolish to suggest that the status quo has been established for ever. There are too many unknowns.

It looks as if the superstores are fighting back against the hard discounters. They may not be halting the march of Aldi and Lidl but they do seem to be slowing it down. Their progress is mostly being driven by new store development, but they already have almost 1,500 outlets and a market share, according to Mintel’s report on Supermarkets - UK, October 2018, of just over 11%.

Online has not made a major impact on the sector and, Ocado apart, it is almost entirely in the hands of the leading superstore groups. But Amazon is showing interest in entering the market in a more determined way and Amazon is always a dangerous competitor.

Such longer term speculation will be considered more fully in the next Mintel report on Supermarkets, due in October 2019.