Asda reaps the benefits of early action on prices

If the supermarkets have indeed been locked in a price war this year, today seems to confirm Asda as the clear winner of round one.

Asda revealed its like-for-like sales grew 0.5% in the 10 weeks ending 30 June – up on the 0.1% organic growth it achieved in the last quarter and comfortably ahead of its rivals, which all saw quarterly like-for-like sales declines in their most recent trading updates.

While 0.5% growth is not usually reason to hang out the bunting, at a time when the British Retail Consortium calculated a 3.5% decline in like-for-like UK food sales for the three months to June, Asda’s growth suggests its doing something right.

So what is the reason for Asda’s relative outperformance? Inevitably it seems to come back to price.

Asda was the first of the big four to launch a concerted price-cutting drive, vowing late last year to invest £1bn in lowering prices over the next five years. It is not just a ‘first mover’ boost that Asda is benefiting from as the Walmart-owned chain has also concentrated on cleaning up its price file by cutting promotions and vouchering.

This effort to bring clarity to its pricing has helped bring Asda clarity of purpose in consumers’ minds. They know Asda doesn’t necessarily fight toe-to-toe with the discounters, but it is consistently the cheapest of the supermarkets that provide the extra trappings and choice that Aldi and Lidl do not.

A detailed analysis of pricing by Bernstein last month found that Asda was barely being challenged in the early rounds of the so-called price war.

“Asda keeps performing best in class in terms of overall price levels (6% cheaper on branded, 7% cheaper on own label), the number of products that are cheaper than the competitors, the number of price cuts,” Berntsein analysts wrote. “It keeps beating the competition on all measures and isn’t losing its edge.”

The 2014 price investments by Tesco and Morrisons have, Bernstein said, been “largely about removing excessive price premiums over Asda, without beating Asda”.

Clearly Asda’s decisive action on price is not without balance sheet consequences. While Asda’s ownership situation means it is not as granular with the financial data it provides as its listed contemporaries, there does seem evidence that it has accepted lower margins as part of the bargain to maintain sales.

Shore Capital analyst Clive Black today noted that Walmart’s Q2 earnings update, in which the US retail giant reduced full-year guidance, revealed that the gross profit rate of its UK business fell during the quarter. Walmart International leader, Dave Cheesewright, said of Asda: “Operating profit declined slightly due to the lower margin mix, which was offset by strong cost control and productivity improvements.”

The big question mark over the sector now is whether incoming Tesco boss Dave Lewis is prepared to slash its market-leading margins – and hefty dividend – to free up cash to jump fully into a price war.

Bernstein noted last month that Tesco had been reluctant to get involved in a full-scale price war, concentrating on a smaller basket of staple own-brand items and only effectively removing its price premiums over Asda.

There is now a growing expectation that Lewis will take advantage of the blank slate afforded to a new leader to sacrifice margin to try to end its haemorrhaging of market share.

Shore Capital’s Black notes: “It is our central expectation that Tesco will further reset its UK margins, so intensifying the competitive environment… Asda is leading the big boys with its focus on price, proposition and costs. That said, the others are following now, which makes for a potentially even more challenging industry.”

Asda is by no means immune from the worsening market conditions – as its recent in-store restructure and cutting 1,360 jobs attest. Its renewed investment in click & collect, which it expects to account for 30% of online orders within five years, also shows price is not the only key factor in the supermarket battle.

The choices facing Asda are just as stark as those in front of competitors - what is the right balance between margin and price and between cost levels and customer experience?

But ultimately Asda is benefiting from being a business that has a USP its customers understand  – that is the greatest challenge still ahead of Tesco and Morrisons.