Making life bitter

Published on Sunday 4 July 2004 00:08

AS SIR Peter Davis stepped out of his office in Sainsbury’s central London headquarters for the final time on Thursday afternoon, he brought an end to a fairly calamitous spell in the history of the supermarket group that once topped Britain’s retail charts.

Strategy reviews and advertising campaigns have failed to disguise the fact that Sainsbury has suffered some serious middle-aged spread. Under Davis’s tenure it has been left standing while its fleeter-footed rival Tesco galloped ahead in the sales stakes and Asda, backed by the finances of US giant Wal-Mart, squeezed it into third place in the UK grocery pecking order.

And although Sainsbury’s performance in the last financial year will be best remembered for profits warnings and the debacle surrounding the suggested appointment of Sir Ian Prosser as Davis’s successor in the chairman’s job, this didn’t stop the board recommending him for a 2.5m bonus, supposedly based on his performance - a bonus which has played a large part in his demise.

But the market had barely had time to get to grips with news of Sir Peter’s fall, or the further severe profits warning that accompanied his ousting, before Morrisons, the blue-eyed boy of the supermarket sector, also confessed that all in the garden was not quite as rosy as had previously been thought. Victory in the long-running battle for Safeway appears to have come at a higher price than previously expected and profits are likely to be "substantially" lower than previously indicated, Morrisons said, which sent its shares into freefall.

With two profit warnings in two days, from two of Britain’s top four supermarket chains this could begin to sound like something of a crisis in the sector. Crisis or not, now that the Office of Fair Trading and Competition Minister Gerry Sutcliffe are beginning to circle the big four over allegations that they are using their dominant positions in the grocery retailing sector to abuse suppliers, it seems that there are ever more challenges for an industry that has largely made its name through uninterrupted growth and explosive profits.

"Sainbury’s problems are pretty much self-inflicted," says Richard Ratner, analyst at Seymour Pierce. And it’s easy to agree with him. Having carved its niche in the 1980s as an upper-middle class retailer that was more concerned with quality than cost, it came to believe that it was protected from the threat of competition posed by the riff-raff battling it out for price at the lower end of the sector - namely Tesco and Asda.

But while these two groups have been able to improve their offerings and move further into Sainsbury’s higher-class turf, it has proved more difficult for Sainsbury’s to keep pace. Where it has attempted to compete on price, the higher volumes haven’t followed.

Sir Peter arrived at Sainsbury as chief executive in March 2000, after leaving the top job at life assurer Prudential. He had left a promising career at the supermarket 14 years earlier after he came to believe he would never get the top job. In between times, he’d also made it to the chief executive’s post at publishing giant Reed Elsevier, where his quick-tempered reputation had begun to establish itself.

He promised a "strategy for the way ahead" which would deliver the goods for shareholders and set the group back on a path to growth that had free-wheeled under the two and a half year reign of his predecessor, Dino Adriano - the first chief executive from outside the family.

Within a few months Davis had sold the Homebase DIY chain for 750m to leave the group free to concentrate on food retailing. Then he recruited Naked Chef Jamie Oliver to front the group’s advertising campaigns under the slogan ‘Making life taste better’. By November 2001, sales growth was at a 10-year high and Davis claimed his three-year recovery plan was on track. But it soon appeared that growth was being chased at the expense of margins, and the shares began their drift lower again. And while Sainsbury had cut prices on a number of lines, it was still a more expensive place to shop than Tesco or Asda, expecting its customers to pay more for what were essentially the same items as those on sale in these rival chains.

For his next trick, Davis effected an expensive overhaul of the company’s distribution and IT systems. But despite investment of several hundred million pounds this too doesn’t seem to have produced a return to shareholders - or certainly not on the scale of what was expected in the City. All in all the group has flatlined while its rivals have raced further and further ahead. Following the latest profits warning, analysts now expect its profits for the year to come in at about 400m - more or less the same as in 1989.

"Without doubt we have seen an intensification of price competition in the sector," said Steve Gotham, senior retail analyst at Verdict Research. "But while some just keep growing volumes, others such as Sainsbury - and now Morrisons, as a result of the Safeway deal - have just cut their margins.

"Overall, we’ve seen the sector split into two distinct groups - the fast-growth group of Tesco, Asda and Morrisons, then the slow-growth group of Sainsbury, Somerfield and Iceland."

Sainsbury’s position in the slow growth group was emphasised emphatically by this week’s news. Ratings agency Moody’s Investor services has now put its already low debt rating of "Baa1" under review, citing concerns that "lower operating margins in Sainsbury’s supermarkets business will constrain operating cashflow generation which may lead to a significantly weaker overall credit profile than had been envisaged".

Capital expenditure has already been cut back from 700m to 500m this year as the group tightens its belt. There seems little doubt that a dividend cut will be the next move on the cards in an attempt to preserve cashflow - a move which is unlikely to please the Sainsbury family, which still owns 38% of the shares. It also seems likely that the continuing furore over Davis’s golden parachute pay-off, which is now being negotiated by lawyers, could also ultimately lead to the ousting of Keith Butler-Wheelhouse from his position as head of the remuneration committee. For some, there is also a belief that Sainsbury could subsequently become a takeover target.

"It is a possibility," said Verdict’s Gotham. "But I see it as a remote possibility. There is still a sizeable holding in the family, which has a strong sentimental attachment to the company and the name I don’t think they would sell out. There would be competition concerns for anyone attempting to buy the stores. If a venture capitalist came in, they would be looking to sell some of the stores on to make their money. But the regulators won’t let the likes of Asda or Tesco just cherry pick the store they want to fill in their estate."

Across the whole supermarket sector, life is not as easy as it used to be. The major players have all grown so fast that they are now competing almost exclusively with one another. Opportunities are becoming limited.

"Everyone needs to eat," Gotham says. "So the sector is not suddenly going to go into meltdown. But it is getting much tougher to keep growing. There is no soft underbelly to the grocery sector anymore. A lot of the smaller players have simply gone or been taken over. The likes of Waitrose and the M&S food division are, to some extent, protected by being further up the chain, but everyone else is in the middle ground battling it out."

Morrisons has found itself placed more firmly in this middle ground since it finally sealed the 3bn acquisition of Safeway earlier this year - a move which was partly designed to give it a stronger foothold in the Scottish market, where Safeway had only recently been beaten by Tesco into second spot. It was Morrisons’ smaller scale and smaller reach that allowed it to complete the deal, with the bigger players having been fended off by competition concerns.

Perhaps the Bradford-based group, which is still led by the family in the shape of Sir Ken Morrison, may have bitten of a little more than it can chew with a deal which instantly quadrupled its size.

Safeway lost its way as it struggled through the lengthy bid process and competition enquiry which surrounded its numerous takeover offers and was latterly propping itself up by keeping prices high and Morrisons has struggled to pull that back. It has slashed prices on 12,000 products at Safeway, bringing them in line with its own, but shoppers have been slow to react. And further benefits from the merger have been slow to materialise.

For now, the market seems tolerant of Morrisons’ news - even though profits look likely to be as much as 33% lower than previously expected at 375m. But it is already scaling back its ambitions. Although the group was forced into selling 52 stores as part of the regulatory undertakings which saw the deal go through, it is now touting offers from its rivals for 120 smaller stores - including a number of its Scottish outlets.

In an industry that has become increasingly competitive, the group has decided to pick its own battles and stick to the format it knows best - bigger stores, where families do their once-a-week shop. It also reckons that once it has rebranded the entire estate into Morrisons livery, sales will begin to turn around.

It would be churlish to suggest that Morrisons had gone chicken, given the bold nature of its move for Safeway in the first place. But a profits warning and a sale of more outlets certainly suggests that the new kid on the block may find it tough to keep pace in a sector that is becoming ever more competitive.

"There is still plenty of growth in the UK market," adds Ratner. "You just need to know where to look for it. It’s not as easy as it once was."