The takeover of Safeway by Morrisons could lead to a price backlash as the merged group battles to lift market share - good news for consumers but not so good for investors in the retail sector, according to Nicholas Jones, retail analyst with Goldman Sachs.
Morrisons will invest more than £500 million in cutting prices at Safeway stores according to the Competition Commission's recent report on the deal, and Goldman Sachs estimated that this is in an attempt to garner an additional 3 per cent market share - not counting the gains it will make by buying Safeway in the first place.
But such an aggressive tactic is unlikely to be taken lying down by the likes of Tesco and Asda, who already pride themselves on being low-price retailers, with the result that a price war could well be on the cards.
Jones said that Tesco in particular should be able to ride out any short term problems entailed by significant price cutting - in fact, its number one position in the UK has if anything been reinforced by the Safeway deal. Nonetheless, the company is expected to see some erosion of its share price if price cutting becomes particularly aggressive.
The analyst also highlighted the restrictions imposed by the Competition Commission on the losing bidders. Morrisons is obliged to sell 53 stores to win final approval for its takeover, but no more than that, while Tesco, Asda and Sainsbury will only be allowed to chose from among these 53 outlets.
This too benefits Tesco, Jones says, as it should be able to buy more Safeway stores than nearest rival Asda (as it has less of a geographical overlap), thus allowing it to further stretch its lead.
Sainsbury, on the other hand, is likely to be the biggest loser from the Safeway takeover, as it already lags some way behind its rivals on price and has little prospect of keeping pace with further cuts.
But Sainsbury's stores compete very closely with many Safeway outlets, and a revitalised performance from the acquired stores under Morrisons' management would pile up the pressure on the already struggling supermarket group - it could even drop to fourth place in the overall ranking, having only recently dropped to third as a result of strong trading at Asda.
But the analyst stressed that the situation is not as bad as it could have been for Sainsbury's, especially if Asda had been successful in bidding for Safeway. This would have created a duopoly between Tesco and Asda, effectively sidelining Sainsbury completely.
Moreover, the Competition Commission's tough stance on asset stripping Safeway - in order to ensure that four strong retailers continue to compete - should ease speculation that Sainsbury might now be a target itself for takeover. Any financial bidder interested in Sainsbury for its real estate value would now be unlikely to succeed.
While Jones was broadly confident that Morrisons could do a good job at integrating Safeway, he also stressed that the short-term problems facing the chain should not be dismissed - in particular the likely reaction to any aggressive price cutting.
At the same time, however, he also said that the synergies from the Safeway deal are likely to be greater than originally estimated, even with the loss of £730 million in sales as a result of the enforced disposal of 53 outlets. The Goldman Sachs analyst estimates that the chain could generate purchasing synergies of around £375 million, as well as significant gains from increasing sales at Safeway's larger stores. In total, the company could make over £800 million in gross synergy gains, But the price investments could also be higher, mainly as a result of further price cutting by Morrisons big rivals. Jones estimates that both Tesco and Asda will look to cut prices at the very early stages of Morrisons' integration programme, although both chains will be keen to ensure that they do not hamper the rest of their business in a bid to compete.
Tesco's UK business is highly cash generative, fuelling its international expansion, and the UK number one will not want to do anything to restrict this growth. Wal-Mart, on the other hand, has a particularly high return on investment level at Asda, and this too must be maintained.