RPT-Fitch: Morrisons Price Cuts Pressure Tesco; Margins at Risk
March 18 (Reuters) - (The following statement was released by the rating agency)
Morrisons' aggressive plan to spend GBP1bn on cutting prices over three years will put pressure on Tesco and other supermarket operators to respond in order to protect market share. This could accelerate margin erosion across the sector in 2014, Fitch Ratings says.
We do not expect an imminent all-out price war. However, existing price-matching offers will cause the cuts to spread. The pressure on prices and pace of restructuring highlights the risk of overcapacity, which ultimately may lead to a sector shake up and consolidation among the fragmented convenience retail segment.
Morrisons is cutting prices to counter the loss of market share to discount retailers like Aldi and Lidl. It has also faced greater competition from ASDA, the major supermarket with which it has the greatest customer and regional overlap in the UK. Morrisons has failed to keep up with the innovations of the industry, such as online shopping and expansion into small convenience stores. Its price cuts will be funded by planned cost savings and potentially by accepting a lower margin. They are more aggressive than the GBP1bn initiative Asda announced in November, which at the time was to be spread over five years.
To limit the impact on margins, retailers will probably respond by accelerating cost cutting initiatives and investment in product ranges and store formats.
Tesco has the strongest margin, but this has been shrinking for several years. It may now be pushed to rethink its pricing in order to defend market share, which has come under pressure as evidenced by weak 2013 Christmas trading. We put Tesco's BBB+ rating on Negative Outlook in December, reflecting the limited scope for accommodating a further fall in margin and loss of market share.
Increased pressure on prices, market share and profitability could also further accelerate the pace of structural change. This could include changes to product ranges, the regional distribution of stores and their footprint or format, as well as property transactions.
Consolidation remains unlikely in the near term, particularly among the big four - Tesco, Asda Sainsbury and Morrisons - because of competition concerns and complexities around issues like pensions. However with the growth of hard discounters and the dynamism of convenience stores, scope may appear for corporate activity involving smaller and regional food retailers in the medium term.