8th October 2014
Tesco has the greatest scope to sacrifice margin as it bids to fight off its discount rivals says Andrew Herberts, Head of Private Investment Management, Thomas Miller Investment.
In a note considering the supermarket wars, Herbert says that discounters which stay disciplined – i.e. maintain their discount strategy and not widen their range – should continue to win a natural market share.
The note says: “Share prices at Tesco, Morrisons and Sainsbury’s have plummeted. The large, traditional supermarkets face competition from both sides of the spectrum and appear to be losing share to the “high end” players and the discounters. Over the last decade supermarkets have been squeezing suppliers on behalf of the consumers that now appear to have turned away from them.
“While the discounters enjoy a higher market share on the Continent than in the UK, the Continental supermarkets have been able to react to the price competition on the high street, though this has resulted in the permanent erosion of margin. In order to remain competitive, Tesco, Morrisons and Sainsburys will need to develop a strategy that blunt the attraction of the discounters, exploit their own advantages in terms of consumer choice and may involve imaginative uses of the space in their vast out of town hypermarkets.
He points out that Sainsburys has made a start with a tie up with Netto, and Morrison has essentially already declared a price war.
The note adds: “Tesco, with the highest share, has most to lose, but it also has the assets and scale to fight its corner. The other grocers should be concerned, because they have much less scope to sacrifice margin.
“If the discounters stay disciplined in their business models, then there is a natural maximum market share that they can take. However, if they lose discipline and end up trying to match the supermarkets in terms of product choice and brand availability then they will end up losing out.
“With Morrisons, Tesco and Sainsbury trading below the value of their net assets the market is now implying a period of value destruction. If investors believe in this outcome, then there is no reason why the stocks could not fall further.
“However, in the end, the big supermarkets aren’t going away, and they will adapt to the new environment. Margins may well be structurally lower, but the major grocers provide a service that consumers are unlikely to be willing to lose.”