Consumer

Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.

(Updated )

Britain's supermarket aisles have been awash with special offers recently. Now it’s the grocers themselves in the bargain bin, and that’s attracting potential shoppers.

Bankers are abuzz at the prospect of consolidation among Britain’s listed supermarkets: Tesco, J Sainsbury and Wm Morrison. Sainsbury is already trying to do a bit of consolidating itself, with a rebuffed billion-pound ($1.5 billion) bid for Argos owner Home Retail Group.

Supermarket mega-mergers – Megashop let's call them – began to look like less of a barmy idea in 2015 when Ahold of the Netherlands and Belgium's Delhaize decided to combine to create a company with more than 54 billion euros of yearly sales. While a big British merger may be tricky to pull off because of market dominance, that doesn't exclude private equity from taking a punt on a weakened sector. 

Grocer Groans
Bloomberg

First there’s the market valuations: retail’s very own version of a money-off deal. In five years, Tesco's shares have fallen 66 percent, Sainsbury's by 38 percent and Morrison by 44 percent.

So listed British supermarkets look pretty cheap when compared to European peers on a price-to-sales basis (see chart below). That might signify an opportunity for anyone willing to take the -- admittedly risky -- gamble that revenue starts to recover over the next few years, or the onslaught from German discounters Aldi and Lidl tails off.

Bargain Bin
On a price-to-sales basis, the British supermarkets trade near the bottom of a range of European peers
Bloomberg Intelligence
Based on trailing 12-months sales

Despite investor hopes, Tesco looks least likely to be part of any deal. The U.K. number one is probably too big (with 28 percent of the grocery market) to get past antitrust concerns, while 17.7 billion pounds of total indebtedness makes it unattractive to private equity.

A combination of Morrison and Sainsbury has more logic. Sainsbury is concentrated in the south of England while northern-based Morrison has never really cracked the market outside its heartland, despite 2004's 3.4 billion-pound acquisition of Safeway.

Putting them together would generate savings, and beef up their buying power with suppliers, useful when countering Aldi and Lidl.

Sir Ken Morrison, whose family still controls close to 10 percent of Morrison, has built a 6 million-pound stake in Sainsbury, intensifying speculation that they might get together.

But as Morrison found when it took over Safeway, supermarket deals can be as messy as a spillage in the dairy aisle. That deal was followed by five profit warnings in 18 months, a first annual loss and a bitter boardroom dispute. It was tied up for months by regulatory wrangling.

Part of the reason for the concept of a U.K. Megashop gaining traction now is that the landscape has changed since the Safeway deal. Back then, Aldi and Lidl had a combined share of about 3.4 percent, according to Kantar Worldpanel, the consumer research group. Today it's 10 percent.

British Supermarket Share
Kantar

Megashop supporters argue that this makes the prospect of the British big four (which includes Wal-Mart's Asda) becoming three much more likely.

But this may be wishful thinking. Competition authorities remain unpredictable. Just look at the decision to launch an in-depth investigation into Poundland’s acquisition of 99p Stores. Even if it did go ahead, Megashop would probably have to sell off a large number of stores.

So a more likely scenario could be a private equity buyout of Morrison, potentially spearheaded by the current management.

Morrison owns 85 per cent of its properties, and while profit has tumbled, it remains cash generative. House broker Shore Capital forecasts free cash flow of 400 million pounds next year. Shore estimates that Morrison shares trade at the same level as its net asset value of 152p per share.

Sainsbury too is of enduring interest to buyout firms. Back in 2007, it was besieged by separate bids from a CVC-led group and Qatar-backed investment fund Delta Two. 

Sainsbury's shares fell last week after it disclosed its interest in Home Retail, showing investors aren't entirely convinced of the strategic logic. If the deal to buy Argos doesn't go its way, Sainsbury could start to look like the biggest bargain on the supermarket shelves.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andrea Felsted in London at afelsted@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net