Sainsbury's / Asda - will Four become Three?
The proposed mega-merger of Sainsbury’s and Asda, March/Q1 retail sales figures from the ONS, further deterioration in trading performance at Bunnings, Poundworld mulling a CVA.
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- The official March and Q1 retail sales figures from the ONS were largely buried under the bad news of CVAs. And they were surprisingly robust. Despite ‘the Beast from the East’, retail sales values were (exc fuel) were up 3.2% year-on-year and volumes (i.e. excluding inflation) were up 1.1% (with department stores the strongest performing sub-sector). For Q1 as a whole, values were up by 3.7% and volumes by 1.2%.
- Bunnings UK & Ireland has reported total sales for Q3 of £211m, a decline of 13.5% in local currency terms compared to the previous quarter. Store-on-store sales decreased 15.4%. For the financial year to date total sales decreased 14.7% to £726m while store-on-store sales decreased 13.9%. Ahead of the official announcement on the future of the business in June, parent company Wesfarmers is reportedly seeking buyers for the business, offering a dowry of £100m.
- Another week, another CVA. Private equity-owned value operator Poundworld is reportedly looking at closing up to 100 stores of its 355 portfolio, while seeking rent reductions from landlords at a number of others. Although the business blamed the macro retail environment, current conditions should in fact favour the value operators. Rather than herald the ‘demise of the pound store’ this is in fact overdue shake-out of what has become an over-shopped sector.
Stephen Springham, Head of Retail Research:
Sainsbury's in advanced merger talks with Asda. North and South Korea reunification. ABBA reforming. I wonder which of these you would have got longer odds on a week or so ago. All seemingly bolts from the blue, I will restrict my thoughts to the one that I most qualified to address.
News that Sainsbury's and Asda are in advanced merger talks broke over the week-end, initially as a leak, but quickly confirmed by the companies themselves. The bare facts as we know them at this stage are that the merger is a 'friendly' one and that the plan is to retain both brands.
My immediate reaction to the news and one that won't go away is that the Competition and Markets Authority (CMA) are going to have a field day, having ironically brought this on themselves with their treatment of the Tesco / Booker merger. Second-guessing the CMA (as I will go on to do) has in fact superseded any analysis I may have done on the whys and wherefores of the deal itself.
Media coverage of the proposed merger has been naive in the extreme. Hyperbole such a "game-changer of epic proportions" does scant justice to something that is far from a done-deal, is hugely complex and could actually be more detrimental to both parties than beneficial.
The rationale cited is equally one-dimensional - effectively to knock Tesco off its perch as the leading grocery retailer in the UK (it has a 27.6% share, Sainsbury's 15.8% and Asda 15.6%, according to Kantar) as well as to "drive improved efficiency through cost-saving synergies".
All very text book, but hard to square in reality if you have a deep understanding of the two protagonists involved and the market in which they trade. Suggestions that the move may trigger a "price war" are frankly laughable - it's the very last thing that a merged Sainsbury's / Asda would look to achieve.
A generation ago, most would have called the proposed merger into question on the basis that there was limited fit between the two suitors, Sainsbury's effectively being far more upmarket than the more value-led Asda. The reality is that the two are now both mass-market operators and that the gap, while still there to some degree, is much narrower now than it once was.
You could even argue that their areas of geographic strength are actually complementary. Both have evolved to become national players, but in general terms, both continue to trade best in their respective homelands - Sainsbury's in the Home Counties and Asda in Yorkshire and the North. Geographic compatibility is one of the areas where the deal actually makes sense.
But if the plan is to retain the two brands and run them as complementary businesses with little front-end crossover (Argos implants in Asda stores notwithstanding) what is point of the deal? On the surface it seems to come back to little more than scale.
Toppling Tesco from Top Spot is a nice story, but there is so much more to retailing than idle bragging rights. Besides, the reality is that a merged Sainsbury's - Asda probably wouldn't be larger than Tesco once all store disposals are factored in.
Larger businesses obviously enjoy greater economies of scale, particularly in the power they hold with suppliers. But it's worth stressing that neither Sainsbury's or Asda are exactly minnows in isolation, so it's difficult to imagine them securing substantially better buying deals in unison. In the case of Asda it would actually be downscaling its buying muscle, if, as we are to presume, it is extricating itself from Walmart's largest-in-class sourcing capabilities.
Over and above sourcing, you could also question the level to which operational cost-saving efficiencies could be achieved.
These are two businesses that have drastically rationalised their operational and head office bases in recent years and there can be precious little fat left. Some central cost-savings maybe, but probably not enough to justify the whole deal.
To my mind, the positive rationales for the deal are far broader than the obvious areas of scale and pricing. On the one hand, it is about improving Asda's core food offer. We have long-argued that Asda's recovery needs to be food-led, Sainsbury's would be far better placed to drive this than Walmart.
Secondly, it is about non-food. Asda has historically been far stronger in this market, but Sainsbury's (even excluding Argos) has made huge inroads in recent years.
Throw Argos into the mix and you have a general merchandise business (the largest non-food retailer in the UK, even?) with huge potential - with a downside risk that achieving that potential is a massive corporate distraction.
To return to the elephant in the room that is the CMA. The CMA inadvertently opened the door to this deal by its surprisingly 'hands-off' approach to the Tesco / Booker merger. Sainsbury's clearly saw an opportunity to test the CMA's resolve further - and frankly why not?
Categorically, the CMA will not just wave the Sainsbury's / Asda deal through. As they are both largely single-branded businesses (Argos and the c-store businesses aside), it doesn't have the option of decreeing that certain fascias or divisions are excluded from the deal.
So, there are only two options: it opposes the deal outright or it undertakes a catchment-by-catchment competition analysis and stipulates store disposals in areas where the merged business has an over-dominant position.
I doubt the CMA will block the deal outright. If they did, both companies would have serious comeback in the form of the precedents set in the Tesco/Booker deal (could they even ask for a re-review?)
The second option seems far more likely, but is a hugely complicated and long-drawn exercise. Have we been there before? Most certainly, when Morrison's took over Safeway in the early 2000s. But that was tangibly different in that both those businesses were a lot smaller and the foodstore "space race" still had a long way to run. The competitive landscape is vastly different now.
Some of the parameters applied back then (e.g. 10/15 minute drivetimes) may still be employed, but others will need to be revisited and revised (e.g. number of competitors within said drivetime, who those competitors are (just Big Four or other players too?), cut-off store size (15,000 sq ft again?)).
To throw in a further curve ball, it is not beyond the realms of possibility that the CMA may launch a separate enquiry on the non-food side.
There will inevitably be some store disposals, but given the number of working parts and uncertainties around what parameters will be set, it is impossible to predict the scale of these at this stage.
Also important to stress is that store disposals are not the same as store closures - many of those outlets identified will simply pass ownership to other operators.
The proposed merger in summary: opportunistic, driven by Walmart's apparent desire to withdraw from the UK and a challenge to the CMA in the wake of its clearance of the Tesco/Booker deal.
Less about scale and pricing, more about driving a recovery in food at Asda and establishment of a multi-channel non-food superpower. Any integration process will be very demanding and resource-intensive. The CMA still has a massively pivotal role to play.
By all accounts, the Sainsbury's - Asda merger has a long way to go before it is sealed, just as ABBA have hit the studio but are a million miles away from going back on the road. But the Sainsbury's - Asda merger also makes the reunification of North and South Korea look straightforward.