Alasdair Ronald, Senior Investment Manager at Brewin Dolphin in Glasgow, looks at what this week’s retail mega merger says about the current M&A climate

When news broke of the potential tie-up between Asda and Sainsbury’s over the weekend, the story may have raised a few eyebrows. After all, these two supermarkets have very little in common and serve very different demographics.

Perhaps that’s exactly why it should have come as no surprise.

The food retail sector has been hit by a series of headwinds in the last few years. Discounters, such as Aldi and Lidl, have had a serious impact on the traditional “big four” British grocers – the two involved in this deal along with Morrison’s and Tesco. In the 12 weeks to 25 March 2018, data from Kantar Worldpanel found that Aldi represented 7.3 per cent of the UK grocery market, and Lidl was on 5.3 per cent.

While the German discounters are chipping away at market share, competition is also coming in other forms. To take one example, Amazon has shaken up the retail sector in a big way over the past decade and, if it follows through with its plans for Amazon Go among other initiatives, that only looks likely to continue.

From that perspective, consolidation as a defensive move makes sense. The Asda-Sainsbury’s merger would see the combined business leapfrog Tesco to command the highest market share in the UK, with 31 per cent. The new business would also have £51 billion in revenues, 330,000 staff, 2,800 stores, and 47 million weekly transactions.

Of course, it’s not just a numbers game. Asda and Sainsbury’s have their own idiosyncrasies, which make a deal look attractive. Asda has struggled with e-commerce and its own labels, while Sainsbury’s pricing hasn’t been as sharp as some of its competitors. Asda is stronger in the north and Sainsbury’s in the south.

Furthermore, their purchasing power would be significantly enhanced by the proposed merger. While Sainsbury’s chief executive Mike Coupe has said there won’t be store closures, his hand may yet be forced by the Competition and Markets Authority (CMA) and it could help remove capacity from an oversupplied market. A combination of the two companies and their respective strengths would certainly make them greater than the sum of their parts.

In truth, it’s anyone’s guess as to how this proposed deal will pan out. But the City clearly likes the idea, with shares in Sainsbury’s markedly up on the day and its competitors flat or down.

What it does show is that an increasing number of companies are looking ahead a couple of years and, if they can’t see growth in their own sales, they’re responding by trying to buy them in from elsewhere. Then, if the new company can cut costs, they begin to widen margins.

Whether it goes through or not remains to be seen. But, from a wider context, the mooting of this merger re-emphasises that we’re moving into the latter part of the economic cycle – there were several deals north of £100 million announced yesterday. We fully expect others matching this type of profile to follow throughout the rest of 2018 and into next year.