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Tesco-Carrefour tie-up a 'direct response' to Sainsbury's-Asda merger, analysts say

Supermarkets have been tackling rising competition from discounters Aldi and Lidl and the growing threat of Amazon
Tesco
Tesco has announced a "long-term strategic alliance" with Carrefour

Tesco PLC’s (LON:TSCO) tie-up with Carrefour is seen by some analysts as a defensive move in response to the proposed merger of rivals J Sainsbury (LON:SBRY) and Asda.

The British and French supermarket groups have agreed a “long-term strategic alliance”, using their joint buying power to cut costs and bring down the prices of items.

READ: Tesco and Carrefour announce strategic alliance to cut costs and prices

It marks the latest of a string of tie-ups in the grocery sector as companies tackle rising competition from discounters Aldi and Lidl and the growing threat of Amazon.com Inc (NASDAQ:AMZN) following its acquisition of Whole Foods last year.

Potentially the biggest threat to Tesco is Sainsbury’s planned £7.3bn takeover of Walmart Inc.’s (NYSE:WMT)  Asda, which is being investigated by the UK’s Competition and Markets Authority. 

READ: Sainsbury's-Asda merger raises competition concerns, CMA reveals

If approved, Sainsbury’s and Asda would overtake Tesco to become the UK’s largest retailer.

Tesco is obviously concerned by the increased potential buying scale of a combined Sainsbury’s and Asda, and both it and Carrefour are worried by the idea of Amazon making more ambitious moves in European grocery retail,” said Patrick O’Brien, UK retail research director at data and analytics firm GlobalData.

“However, it should be noted that a key focus of the tie-up is to reduce prices on own-brand products, and this is more of a direct response to Aldi and Lidl, whose offers are heavily weighted towards own-brand.

Tesco and Carrefour have both struggled to match the discounters on quality and price, and the alliance should help it compete.”

Another price war on the horizon, says Hargreaves Lansdown

Laith Khalaf, senior analyst at Hargreaves Lansdown, said Tesco’s partnership with Carrefour looks like a “direct response” to the threat posed by the proposed merger of Sainsbury’s and Asda, which will have access to the global buying power of Walmart.

The analyst believes another price war is now looming in the UK supermarket sector.

“A price war is great news for consumers, but it’s tinged with risk for shareholders,” he said.

“In theory, the big supermarkets can use greater firepower in the supply chains to lower prices, drive more sales, and perhaps even keep a bit more margin for themselves.

“However the risk is that a tit for tat price war spirals out of control, and ends up lowering profit margins across the industry.”

Other analysts reckon the Tesco-Carrefour deal will put the two in a stronger position to cope with the Sainsbury’s-Asda merger and ongoing competition from Aldi and Lidl.

Tesco restructuring efforts

Tesco has been trying to reduce costs and claw back market share through a radical restructuring under chief executive Dave Lewis, who joined in 2014 after the group's accounting scandal.

The turnaround plan has included selling off a number of businesses, including South Korean chain Homeplus, and shutting down the clothing and homewares website Tesco Direct.

In March, Tesco completed the acquisition of wholesaler Booker for £3.7bn, which is expected to create cost synergies for the enlarged company.

READ: Tesco completes £4bn takeover of Booker after getting shareholder approval last week

“Chief executive Dave Lewis seems intent on not only repairing Tesco following previous strategic mistakes such as expanding too much overseas and a high profile accounting scandal, but also fortifying the business for the next stage of its evolution,” said Russ Mould, investment director at AJ Bell.

“Combining forces on the purchasing side could give Tesco and Carrefour stronger buying power, thereby securing goods cheaper.”

Mike van Dulken, head of research at Accendo Markets, said he thinks the tie-up is likely more focused on protecting wafer-thin margins than benefitting consumers.

As publicly-listed companies, fiduciary duty is to shareholders rather than to consumers, he said.

Preparing for Brexit

Van Dulken added that the deal could also help cushion the blow of Brexit for Tesco and Carrefour.

The UK’s vote to leave the European Union has already caused a headache for retailers in Britain as the pound has weakened, pushed up cost inflation and prompted consumers to cut back on spending.

Van Dulken said the timing and geographical proximity of the parties involved is “not lost on us as the UK edges closer to what could prove a highly disruptive Brexit”.

“It is highly likely that today’s news is fuelled by fears of what Brexit might do to cross-channel trade and finely tuned supply chains, especially in terms of perishables like fresh food,” he said.

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