Supermarket squeeze for Irish suppliers if UK giants cash in
Consolidation in the British retail space will put pressure on Greencore and others to crunch prices, writes Dan White
The Sainsbury's/Asda merger announcement last week creates a retailing giant that will squeeze Irish suppliers hard.
The merger will combine Sainsbury's, currently number two in the UK grocery market with a 15.9pc share, with Asda, the number three with 15.5pc. The combined entity will leapfrog the current market leader Tesco, which has a 27.6pc share.
The deal will sweep aside the 'Big Four' that has dominated British food retailing for the past decade-and-a-half. It will give way not so much to a 'Big Three' but a 'Big Two' with number four Morrison, which has a 10.5pc share, receding ever further in the rear-view mirror as Tesco and Sainsbury's/Asda battle it out for market supremacy.
"This is a pivotal moment for the British grocery market. A merger between Sainsbury's and Asda would transform the traditional landscape, placing nearly a third of market share in the hands of the joint supermarket giant, though the march of the discounters - and any enforced store closures - could impact this figure", said Fraser McKevitt, head UK retail and consumer insight at market research firm Kantar Worldpanel.
The merged company will have annual sales of £51bn (€57bn), 2,800 stores in the UK and 330,000 employees. It is targeting annual cost savings of "at least" £500m.
So where are the £500m (€566m) of annual cost savings going to come from?
One of the first things that will happen if the deal gets the go-ahead from the UK's Competition and Markets Authority - which seems likely given that in 2017 the CMA waved through both Tesco's acquisition of wholesaler Booker and the Co-op's takeover of symbol group Nisa - is that the Sainsbury's and Asda buying teams will get together to go through every supplier contract with a fine tooth-comb.
Where they find that a supplier is being paid a higher price by either Sainsbury's or Asda, that supplier will very quickly come under extreme pressure to agree to the lower price for their entire business with the merged company instead. With only two retailers controlling over 60pc of the total market, most suppliers will have little choice but to take it on the chin.
"A merger between Sainsbury's and Asda would result in substantially increased buying power for the combined entity. Downward pricing pressure on suppliers is therefore one of the likely outcomes if the merger is approved," says Paul Kelly, director of Ibec's Food and Drink Ireland that represents most Irish suppliers.
"This adds another layer of uncertainty to the business environment faced by Irish food and drink exporters to the UK and comes on top of a massive weakening in sterling over the last 24 months, Brexit and growing moves by some retailers (as in other European markets) towards domestic sourcing policies (particularly for meat and dairy)".
To see what this might mean one has only to look at what has already happened to Greencore, the former Irish Sugar Company. Its share price fell sharply last week following the announcement of the proposed merger as investors worried about the impact of the merger on its sandwich business, which supplies both Sainsbury's and Asda.
"It [the merger] has come as quite a shock. It was not expected that the number two and three retailers would merge in this way. The large companies are most exposed," says Michelle Butler, Bord Bia's UK market manager.
In addition to Greencore, the Irish-quoted companies most vulnerable to a merged Sainsbury's/Asda are Kerry, Glanbia and Total Produce. Major non-quoted Irish food companies that could find themselves in the firing line include Ornua (the former Irish Dairy Board) and Larry Goodman's ABP, which is the principal beef supplier to both Sainsbury's and Asda.
Kerry published its first-quarter interim management statement last Thursday, in which it revealed a 3.7pc increase in business volumes during the first three months of the year and reaffirmed its full-year earnings guidance.
"Kerry is guiding little or no impact [from the merger]. While there will be some pressure on pricing in consumer foods, Kerry is also helping other suppliers to reformulate their products on the nutrition side. This means that there will be little, if any, net impact," says Investec food analyst Ian Hunter.
He also predicts that Total Produce will be relatively unscathed by the merger.
"Fruit and veg is very resilient. It is the first thing on the way in to every store. The distributors work on such low margins [Total Produce had a 2017 operating margin of just 1.6pc in 2017] that the multiples allow pricing to go through".
The merger announcement comes less than two years after the UK voted to leave the EU. Ironically, the shock of the Brexit referendum result may have left Irish suppliers better prepared for the Sainsbury's/Asda merger.
"Irish suppliers are very resilient. They have already endured Brexit and have invested in innovation, cost reduction and other markets. They are now in a much better position than they were two or three years ago," says Bord Bia's Butler.
The proportion of Irish food and drink exports being sold in the UK has fallen from 41pc in 2015 to 35pc in 2017. However, the strong growth in Irish food and drink exports over this period means that the value of Irish food and drink exports to the UK increased marginally, from €4.4bn in 2015 to €4.5bn in 2017.
The merger is being driven primarily by the rise of German discounters Aldi and Lidl, who between them now have 12.7pc of the UK grocery market (still only just over half the discounters' 22.8pc share of the Irish market). All of the other UK supermarkets are under unrelenting pressure to match the discounters' prices.
Their response has been to develop a core range of a couple of thousand items on which they seek to match the discounters on price. Suppliers, including those from this country, of these core products have already seen their margins squeezed.
This price pressure will become even more intense when the merger is consummated, probably in late 2019.
The challenge for Irish suppliers will be to develop new, higher-margin lines to offset this margin erosion. "Irish companies may have to take a hit on their margins in key lines and try to make it back on new lines", says Butler.
"With two players having over 60pc of the market they will be the ones who dictate pricing. All of the others will have to follow their lead. Supermarkets are now competing virtually exclusively on price and special offers," says Hunter.
Sunday Indo Business