Sainsbury’s and Asda merger to shake up UK grocery market

‘This is a transformational opportunity to create a new force in UK retail, which will be more competitive and give customers more of what they want now and in the future. It will create a business that is more dynamic, more adaptable, more resilient and an even bigger contributor to the UK economy,’ – Sainsbury’s Chief Executive Mike Coupe.

After revealing they were in advanced talks over the weekend, Sainsbury’s and Asda (owned by Walmart) have confirmed plans to merge and create the biggest supermarket chain in the UK, surpassing the current market leader Tesco, which recently completed its acquisition of the country’s biggest food wholesaler Booker Group.

Asda will fold into Sainsbury’s, but both brands are to remain independent. Ultimately, the merger will bring together the expertise of Asda, its owner Walmart, Sainsbury’s, and Argos to create one of the country’s biggest retailers and employers.

Learn more about whether Argos make Sainsbury’s the pick of the UK grocery sector?

So what’s the rationale behind the deal, what would be the impact on the market, and what hurdles could the merger possibly face?

Why are Sainsbury’s and Asda merging?

‘Bringing Sainsbury's and Asda together will result in a more competitive and more resilient business that will be better able to invest in price, quality, range and the technology to create more flexible ways for customers to shop,’ – Sainsbury’s.

The merger is in response to the increased competition across grocery, general merchandise, and clothing within the UK. The pair are also looking to capitalise on each other’s regional dominance, with Sainsbury’s proving more popular in the south of England and Northern Ireland compared to Asda’s strength in the north of England, Scotland, and Wales. In addition, the two plan to complement one another by combining Sainsbury’s smaller, convenience-like stores with Asda’s larger, warehouse-like premises.

Sainsbury's operates over 600 supermarkets and more than 800 Sainsbury's Local convenience stores, as well as over 800 Argos stores - more than 2200 locations in total. Asda has 584 grocery stores, 18 standalone petrol filling stations and 33 Asda Living stores. Asda also owns the leading UK clothing retailer by volume, George, with both an in-store and online offering.

Sainsbury’s is still integrating Argos into its portfolio, and is opening up Argos stores in its supermarkets and by merging with Asda, it will be able to roll-out this programme to more stores. It is thought Argos currently accounts for about £1 of every £5 of revenue that Sainsbury’s generates.

Sainsbury’s-Asda merger: details of the deal

The financial details of the merger between Sainsbury’s and Asda are as follows:

• The deal values Asda at a total of £7.3 billion excluding debt, cash and pensions
• Walmart paid £6.7 billion for Asda back in 1999
• Sainsbury’s will pay £2.98 billion in cash and issue shares worth £4.3 billion, so Walmart owns 42% of the enlarged business
• Sainsbury’s is to fund the cash element using third-party bank finance, before replacing it with longer-term funding
• Walmart will hold voting shares equal to a 29.9% stake in Sainsbury’s, with the rest of its stake made up of non-voting shares that can be converted into voting shares
• However, Walmart cannot hold over a 29.9% voting stake in Sainsbury’s, meaning it will have to sell down some of its voting shares before converting non-voting shares
• Sainsbury’s largest shareholder, the Qatar Investment Authority, has said it will back the deal
• Sainsbury’s and Asda expect the deal to be completed in the second half of 2019, subject to regulatory and shareholder approval

What would the merger mean for the UK grocery market?

The merger will create one of the country’s leading retailers of groceries, clothing and general merchandise which, if combined, would have generated about £51 billion in revenue in 2017. This can be compared to market-leader Tesco, that booked annual revenue of over £57 billion in its recently-ended financial year.

Read more about whether there is a renaissance for Tesco’s share price

However, based on the latest market share data from Kantar Worldpanel, the combination of Sainsbury’s and Asda would see their share of the UK grocery market rise to 31.4%, overtaking Tesco’s 27.6% share. That would also create a chasm between what would be the top two supermarket chains and the rest of the market. Morrisons is currently the fourth biggest chain in the UK with a 10.4% share of the market.

Read more about how is the UK retail sector performing and what is the trading opportunity?

What are the benefits of Sainsbury’s and Asda merging?

Sainsbury’s and Asda intend to keep both brands, and the company will be chaired by the Sainsbury's chairman and led by the Sainsbury's CEO Mike Coupe and Chief Financial Officer Kevin O’Byrne. Sainsbury’s current Chairman David Tyler is to be replaced within the next year after holding his position for eight years. Asda will continue to be run from Leeds, with its own CEO Roger Burnley joining Sainsbury’s operating board.

What are the potential benefits of Sainsbury’s and Asda merging?

• Allow investment in price, quality, range and creating more flexible ways to shop in stores and through digital channels, with the expectation of lowering prices by 10% of ‘many of the products customers buy regularly’
• Generate net earnings before interest, tax, depreciation and amortisation (EBITDA) synergies of ‘at least’ £500 million, after taking the planned investment in pricing into account
• Securing Walmart as a long-term and substantial shareholder
• Deliver double-digit earnings per share (EPS) growth, and low double-digit return on invested capital by the second full financial year after the deal has been completed
• Reduce Sainsbury’s lease-adjusted leverage by utilising Asda’s high freehold property ownership – 75% of Asda’s retail space is freehold, versus Sainsbury’s 50%
• Improved cash generation to help deleverage the combined business and enhance shareholder returns, with expectations for an investment grade credit profile on completion
• To open up Argos in Asda stores, and combine two major clothing brands, George and TU

The two companies expect to deliver net-synergies of ‘at least’ £500 million after investing in the likes of prices and its wider customer offer. About £230 million of those synergies will come from increased buying power, £75 million from property synergies including rolling-out Argos into Asda stores, and a further £75 million will be saved in operational costs.

However, about £150 million will need to spent in order to create those synergies and savings, and another £600 million will have to spent on fusing their IT system and opening up Argos stores in Asda outlets. Sainsbury’s believes there is scope for further synergies and savings to be delivered, and highlighted its track record after stating it expects to deliver £160 million worth of EBITDA synergies from the Argos deal six months earlier than planned.

How are Sainsbury’s and Asda performing?

Asda’s financial year coincides with the calendar year and while results for 2017 have yet to be audited, Sainsbury’s said Asda generated £22.2 billion of revenue and an operating profit of £720 million. Revenue rose from £21.7 billion in 2016 following a return to volume growth in its own label grocery and fresh food units, but operating profit declined from £854 million as expected after Asda invested in pricing and its overall customer experience.

Asda has also made a strong start this year, after delivering its fourth consecutive quarter of like-for-like sales growth in the first three months of 2018, when profit also returned to growth, Sainsbury’s said.

Meanwhile, Sainsbury’s released its own annual results covering the 52 weeks to 10 March as it announced the deal with Asda. Sainsbury’s reported annual revenue of £28.5 billion and underlying operating profit of £694 million. Both grew from the previous year, when revenue was £26.2 billion and underlying operating profit was £688 million.

Sainsbury’s over-delivered, after delivering £540 million worth of savings over the past three years, ahead of the £500 million target. Sainsbury’s is now aiming to trim another £500 million over the next three years. Net debt has also fallen by £113 million to end the year at £1.36 billion, with the aim of slashing that figure by another £100 million this year. In terms of returns, Sainsbury’s annual dividend remained flat at 10.2p.

Sainsbury’s and Asda share prices: a technical analysis

The news has sent Sainsbury’s shares to a level not seen since July 2014. Crucially, the shares have broken through the highs of 2016 at 284p, and have also moved above the 302p level that acted as support in early 2014. From here, the 2014 high at 349p comes into play. A move to 400p would put the shares at their highest level since 2013. The big level to watch is 400p, since it stalled progress in 2010 and 2013. The shares look to have found the fundamental catalyst needed to break the range that has dominated since 2014.