Asda has taken a giant leap into the small store format with its purchase of Netto. But just how good is the fit? Chloe Ryan and Adam Leyland report

As recession started to grip Britain in the summer of 2008, Netto's failure to grow its share while rivals Aldi and Lidl stormed ahead saw operating profits plunge by 50%.

The discount chain's international MD Claus Juel-Jensen did his best to turn things around, bringing in Charles Kay to replace Richard Lancaster, and altering the mix to reduce its exposure to discretionary non-food sales. 

The result was a return to profits of sorts, up 41% to £6.9m last year, but with Juel-Jensen complaining of "crazy prices being offered for grounds just to buy market share" (The Grocer, 4 July 2009), it was clear Netto didn't have much of an appetite for the highly competitive UK market. And last week Netto's ambivalence was made manifest, disposing of its 193-store UK estate to Asda in a £778m deal.

So just how good a fit are Asda and Netto, and how can Asda unlock the value in an underperforming chain of stores?

At half the price paid by The Co-operative Group for Somerfield's 880 stores in which Asda is understood to have expressed an interest it doesn't look like great value, though a source close to the deal told The Grocer that with 80% of the estate freehold, the value of the freehold on the properties was worth as much as £200m.

Nonetheless, industry experts have expressed surprise at the price paid. "Asda paid circa £33x EBITDA so it is clearly taking a very positive view of the upside potential that exists from the portfolio," says one City source. 

"Netto has 193 small stores in sub-optimal locations. It has had a poor trading record through the recession and has just 0.7% market share. The price being paid appears very full, bearing in mind the stores are, we suspect, only marginally profitable. On a per sq ft basis, the price paid is just over £500."

Unquestionably, the demographic fit between the two businesses is encouraging, however. Research by Him! shows the Netto shopper profile has much in common with Asda's. It is skewed towards lower-demographic consumers, with two-thirds not in full-time employment. The main difference is in shopper age, with Asda tending to attract younger shoppers and Netto appealing to older people.

Him! also believes that despite the high density of stores in the north of England, there is minimal risk of cannibalised sales as just 4% of Asda shoppers also shop at Netto in a typical month. Netto stores are used predominantly for top-up shops, with Him! research showing 90% of trips to the chain are to supplement a main shop.

'These aren't c-stores'
The acquisition of Netto will enable Asda to offer a small supermarket format on a nationwide basis. It previously boasted just 26 such stores. But admitting rivals such as Morrisons had stolen a lead, in April it promised to open 100 smaller supermarkets by 2015 a target it's effectively met in just two months.

Judith McKenna, Asda's chief financial officer, says the acquisition "balances the Asda portfolio". And crucially, she claims the acquired stores, despite an average size at the very bottom end of its 8,000 sq ft to 25,000 sq ft target size, will not purely serve as top-up shops.

"These aren't c-stores. You can do a weekly shop in these stores and that is key to the economics of this and making it work from an Asda perspective."

A full weekly shop
Asda plans to completely overhaul and rebrand the stores, stocking up to 10,000 SKUs modelled on a scaled-down small shop including a wide range of fresh foods. Netto stores typically stock just 1,800 SKUs. There will also be room for a non-food offer in many stores, according to McKenna. "We are confident these stores will allow us to offer a full weekly shop to Asda customers and we'll aim to put a small non-food and George offer in as many of the stores as we can."

Asda will also introduce its new Click and Collect offer into the majority of stores. "We've currently got this in all of our 27 small supermarkets, so customers order online from our Direct business or our George business and collect in store," says McKenna.

She refuses to discuss sales targets but analysts estimate the 1.7 million sq ft of extra selling space could generate annual sales of £1.3bn. "It gives Asda the opportunity to be aggressive with suppliers and get better terms across the whole business, which is probably worth at least 50 base points of margin improvement, equivalent to £100m," says one analyst.

Most observers also believe the Netto estate is small enough for the deal not to pose competitive issues and is unlikely to engender regulatory scrutiny. "Asda aspires to run as many Netto stores as possible and is confident the number of disposals will be limited," says Charles Kay, MD of Netto UK.

And analysts believe Asda won't be crossing further small supermarket store openings off its to do list. "They'll aim to open another 70-80 organically over the next five years," says Shore Capital's Clive Black. "I expect them to buy small batches of stores from a number of players."

Meanwhile Netto staff have been waiting to learn their fate.

'Minimal' job losses
Kay, who will remain in his post for 12 months to oversee the transition to the Asda fascia, promises that despite the inevitable closure of Netto's distribution network and head office, which will begin in the new year, job losses will be minimal. "We have been very open with our people that [the business] won't operate as [it does] today, but Asda has made a number of commitments, which they delivered in person at each of those locations last week," he says.

"Firstly, there'll be no changes here in employment levels or the work people do until the new year that's because the work is going to continue unchanged until a very significant number of stores have converted to Asda. Secondly, as work transfers to Asda House in Leeds and Asda's DC network, Asda will do all it can to find alternative roles for anyone who might be personally impacted."

McKenna says Asda expects the converted stores to employ twice as many staff as the Netto stores.

The future for Netto suppliers, however, looks less secure. "Speaking as a supplier who does about £500,000 sales per year into Netto and zero into Asda, there will only be a negative impact on us and probably the hundreds of other smaller suppliers who are able to trade with Netto currently but don't with the big four," one supplier told The Grocer.

Read more
Netto: ‘OFT won’t force Asda to sell our stores‘ (28 May 2010)
Asda in shock swoop for discounter Netto (27 May 2010)