Another day, another dollop of bad news for management of the big four grocers as news broke that German budget chain Aldi has earmarked £300m for investing in new and more modern stores across the UK.
This unwelcome news will certainly put a damper on celebrations at WM Morrison (LSE: MRW) after the northern-centric grocer recorded its third straight quarter of positive like-for-like sales in Q2. Morrisons has been able to engineer this mini turnaround by selling off its many convenience stores, investing heavily in modernising existing supermarkets and doubling down on its wholesale offerings.
Aldi’s investment won’t halt the positive results from Morrisons’ much-needed internal improvements, but it does illustrate that the larger problem facing the sector is no closer to being solved.
This problem is, of course, the vicious price wars that have destroyed margins across the industry as a result of the increasing popularity of German budget chains. We have to look no further than the dramatic fall in Morrisons’ operating margins to understand just how devastating these price cuts have been. Underlying operating margins during the latest half year were 2.6%, fully half of the 5.2% posted this time five years ago.
And, while underlying margins did move in the right direction over the last year, up 26 basis points, the traditional grocers are still in trouble. This is because Aldi and Lidl are still expanding their market share at a steady clip, forcing traditional competitors into further discounts to retain customers.
According to Kantar Worldpanel, this time last year Morrisons claimed 10.7% of the UK grocery market, while the two German firms accounted for 9.8%. Fast forward to today and Morrisons’ share is down to 10.4%, lower than the 10.8% controlled by the Germans.
Morrisons is moving in the right direction due to cost cuts and revamped offerings, but the seemingly inexorable rise of the German firms and the price wars left in their wake make me believe there’s a definite ceiling to what the ‘new’ Morrisons can achieve.
Betting on Argos
It’s a similar story for Britain’s second largest grocer, J Sainsbury (LSE: SBRY). Sainsbury’s market share over the past year has fallen from 16.2% to 15.9%. Perhaps seeing the writing on the wall, Sainsbury’s went out and made a rather dramatic £1.4bn acquisition earlier this year in the form of Argos parent Home Retail Group.
Sainsbury is hoping that putting Argos branches inside existing big box supermarkets will entice customers into branches suffering from lower footfall as shoppers shift back to favouring high street express locations.
Now, this could work swimmingly. But there’s enough academic literature out there describing the pitfalls from mergers such as these to scare even the most optimistic investor. Furthermore, investors with a long memory may remember a similar business plan in the late 2000s when grocers raced each other to open massive hypermarkets selling clothes and electronics alongside food. Needless to say, that plan didn’t work out too well.
Add in the fact that Argos was already struggling due to competition from Amazon and the logic behind this deal looks increasingly fuzzy. Sainsbury’s management should be commended for thinking outside the box, but with competition for food customers only heating up I won’t be buying shares of the grocer/retailer anytime soon.