More than £1.6bn has been slashed from the value of the UK’s three biggest publicly listed supermarkets after a respected analyst warned that Asda is preparing to fire the first salvo in a summer price war that could “wipe out” its rivals’ profits.
Tesco’s shares slid by 8%, Sainsbury’s was down almost 4%, and Morrisons fell more than 7%, after the HSBC analyst David McCarthy issued a dire warning about supermarkets’ prospects.
McCarthy pointed to comments made by David Cheesewright, the head of international operations at the US retail titan Walmart, which owns Asda. Last month, Cheesewright told shareholders he would prioritise sales volume over profit, signalling that Asda will slash prices in an attempt to keep customers coming through its doors.
Since then, it has been announced that Asda’s long-serving chief executive, Andy Clarke, will step down at the end of this month. He is being replaced by Sean Clarke, a former Asda employee who most recently ran Walmart’s Chinese business, potentially signalling a change in strategy. In a note titled “Defcon 1” issued on Wednesday, McCarthy said: “If Asda decided to invest half its margin into price, a competitor reaction could wipe out almost all industry profitability and would force an industry restructure.”
Asda enjoys a higher profit margin than most rivals, meaning it can cut prices aggressively before it stops making money. This could force other supermarkets with smaller profit margins to follow suit and sacrifice profits to maintain market share, he said. “If Asda does reposition fundamentally, then it could seriously damage sector profitability,” said McCarthy.
He downgraded Tesco’s and Morrison’s stock as analysts at Redburn also issued a note downgrading Tesco shares to a sell, after slashing its estimate of the fair value of the supermarket’s stock by half. Redburn analysts James Tracey and Emily Want said new analysis suggested there needed to be a 20% to 30% cut in store space for the major supermarkets to increase their profit margins by the amount currently expected by the City.
They said any increase in food price commodities as a result of the falling value of the pound following the vote to leave the EU was likely to be offset by supermarkets’ need to keep prices low in the face of rising competition from cafes and restaurants and a slowing UK economy.
Amid rising competition from discounters Aldi and Lidl and commodity price deflation, food prices have been falling for more than three years. Grocery prices fell a further 0.8% in June, according to the British Retail Consortium-Nielsen Shop Price Index.
While some forecasters are predicting that food prices will start rising again due to the pound’s weakness after the EU referendum result, a price war could limit the impact on consumers. McCarthy said any price cuts by Asda would be aimed at arresting a decline in sales by restoring its image as the value option on the high street.
The retailer has found its price position undermined by the fast-expanding discounters who offer considerably cheaper prices on the narrow range of goods they offer. Asda has also come under pressure from the rise in online shopping and switch away from the kind of large supermarkets it operates to small local stores.
Asda has cut prices in the past year, but Aldi and Lidl have pledged to maintain the differential by cutting their prices too. The two discounters now control more than 10% of UK grocery sales and are seeing double-digit sales growth as Asda’s sales continue to slide.
McCarthy, who said he expected Asda to cut prices before the end of summer, added that it would be difficult for Walmart, the world’s largest company by revenues, to back down. “If Asda does nothing now, and sales continue to decline, [Walmart] International management would lose credibility.”
The analysts’ comments come after other analysts suggested any price cuts by Asda would only serve to bring it more in line with the rest of the industry. “There is as much about catch up than any new industry pricing paradigm from Asda to us,” analysts at Shore Capital wrote in a note.
They suggested that Asda’s poor performance relative to its peers was as much to do with uninspiring, poor quality groceries as price and that it would take time for the chain to improve its overall offer.
Shore Capital added: “We believe that Aldi and Lidl should have more worry lines about Asda getting its act together, should it do so, than any other organisation in the trade.”
