It takes two to make a market. In the market of opinions, there is a view in one camp that Asda is going to crush UK grocery gross margin structures and wipe out industry profitability as it seeks to stem a sustained period of trading weakness. In doing so, Asda will by implication bring down its peers, making it time for investors to check out of the sector.
We happen to sit in a duller, more boring camp; one where Asda is keener on pricing and shouting about it more effectively for sure but where it implements a strategy for self-improvement in a more precise and considered manner. This may mean its parent, Walmart, can look for the possibility of further profit contribution and dividends to its international division. Hence, we do not expect retail Armageddon for the British grocers. Indeed, we are a little more sanguine.
It is not a given that a price-only strategy would improve the profit sustainability of Asda, noting that it is still just about the cheapest superstore group in the UK. A slash and burn of its 2015 4.7% reported margin (we sense that will be a good deal lower by the end of 2017 through negative operational gearing, the national living wage and planned price investment) would simply transfer value from investors to customers irrationally.
Furthermore, in seeking to protect profitability, Asda has arguably cut costs at the wrong time, particularly given the progress made by its competitors. So, we see ‘cost’ having to go back into the business, including the rebuilding of the management team, to improve the offer in its broadest sense because, frankly, Asda is boring at a time when the art of selling is improving across the trade. As such, we see no quick fix with stabilisation the first priority for Asda management based on a wide range of improvements to the offer.
Easing food deflation, stable underlying demand, the benefit to densities from the broad moratorium on superstore openings, extensive cost cutting and capital discipline actually leads us to believe the sector has been through its darkest hour. There are bumps in the road to come for sure, but ultimately better management steering the industry to a demonstrably calmer place, far from Armageddon.
Clive Black is head of research at Shore Capital Stockbrokers