Invest-ability daily 04/10/21: Supermarket Sweep

Why the Morrisons takeover might be the end of the road for grocery sector M&A

Photo by John Cameron on Unsplash

Supermarkets are topping the charts today as the end of the bidding war for WM Morrison sparked speculation as to which grocer will be next on private equity’s shopping list. I wouldn’t say it’s a given that it will be any of them, but with the market it always seems to be a case of “please, sir, can I have some more” anyway.

Morrison eventually succumbed to a 287p a share bid from US private equity group Clayton, Dubilier & Rice, pipping rival Fortress to the post by just a penny. The deal values Morrison and its debt at just under £9.97bn, more than £1bn more than its first approach but less than the market had expected – Morrison’s shares had risen to just shy of 3 quid a share before the auction was concluded at the weekend.

That’s one reason why we don’t think we will see an imminent wave of takeovers in the supermarket space – put simply, there isn’t a lot of wiggle room in the numbers. Selling groceries is thin gruel these days, ultra-competitive and low margin, especially with the continued march of Aldi and Lidl. Their classic discounter approach of fewer items and a leaner operating model enables them to lead on price and forces the major supermarkets to discount in a way their more bloated structures can ill afford. Aldi has plans for another 100 stores in the coming year.

Margins are facing further pressure as the business of selling food moves online. Supermarkets have said relatively little about digital profits over the years, and for very good reason – there haven’t been many; the move online is more about keeping customers through extra convenience and that comes at a price.

The balance of power between buyer and seller is shifting, too. Branded suppliers of ‘must stock’ products can’t be pushed around as easily as they were in the heyday of the giant grocers, which means supermarkets can’t force them to bear the brunt of heavy discounting. And it’s not just branded suppliers who are pushing back – a tighter market means sellers can pick and choose who they do business with. I recently heard a very interesting story from a major UK lettuce grower, who told me that his supermarket customer demanded they sell them their produce for pretty much what it cost to grow them. The supplier did not acquiesce as it could sell them elsewhere. In short, supermarket buying power isn’t what it used to be.

Then there are the arguably unique circumstances around the Morrison deal. The takeover isn’t happening because its buyer thinks there is a massive opportunity in the UK grocery market – it’s happening because Morrison is sitting on a huge amount of freehold property (it owns 85 per cent of its stores, way higher than Sainsbury or Tesco), which the buyer can borrow against and cream off cashflows – the classic private equity playbook, and exactly why PE has been sniffing around the broader European sector.

Meanwhile, the recent flurry of corporate action means neither Tesco’s nor Sainsbury’s shares appear cheap any more. The losing bidder in the Morrison deal, Fortress, may have said it’s still interested in the UK market, and Sainsbury has hired advisers to protect itself from unwanted attention. But the reasons shares in supermarkets have been in a long downtrend have not gone away and have arguably intensified – that’s plain to see in Sainsbury’s figures in particular and why I wouldn’t put great expectations on a possible bid.

You can read Phil’s thoughts on the sector and the implications of the Morrison deal for free here.

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