Price deflation splits UK supermarket sector

By Anita Awbi

- Last updated on GMT

Related tags Sainsbury Supermarket Wal-mart

Asda Wal-Mart and Tesco have managed to sew up the competitive
British grocery market, as close contender Sainsbury's struggles to
keep up with their low pricing strategies.

Over the past two years the top two supermarkets have worked to drive prices down, engaging in a price war that has drawn competitors in - including the troubled Morrison's chain.

In response, Sainsbury's cut 8,500 product prices over the past 12 months, initiating in-store price deflation of 1.5 per cent as it fought to compete with the low-priced market leaders.

But the London-based firm is still stuck in third place according to TNS Worldpanel figures, currently commanding a 16 per cent share of the UK grocery sector.

Close competitor Asda has maintained it's 16.4 per cent share and is beginning to see growth above the three per cent sector average.

Moody's investor service has now downgraded Sainsbury's short-term ratings, claiming the firm has "weak credit metrics".

Although Sainsbury's has been able to deliver strong like-for-like development in recent quarters, price deflation and increased costs have put pressure on the company's margins "which have been on a declining trend and remain at a low level relative to those of peers"​, Moody's said.

The firm claims Sainsbury's may be challenged to deliver sustainable sales growth in the current retail climate.

"The highly competitive nature of the UK food retail sector, coupled with the company's recent and expected ongoing investments in pricing, constrain operating margin progression,"​ it added.

However, the analyst said the retailer's outlook should improve gradually, as like-for-like sales continue their upward trend.

The supermarket chain recently posted an underlying pre-tax profit of £267m for the year ending 25 March 2006 - up from £238m the year before. Operational profit moved into the black after a troubled few years, reaching £58m compared to 2005's loss of £187m.

"We have made good progress during the year and we are on track in our Making Sainsbury's Great Again plan,"​ CEO Justin King said.

"However, it is early days in our recovery. We still have much to do to drive further improvements but our focus remains on putting the customer at the heart of all decision-making,"​ he added.

The company has a long way to go before it can turn around nearly a decade of disappointing market performance in the face of Tesco's formidable rise to the top.

Goldman Sachs still indicated that the operational improvements seen "are not enough to carry the current operating margins to the industry-beating level that the current share price implies."

"It will therefore be crucial for the markets to get an update on any cost cutting initiatives, or a clear explanation as to how a full margin recovery is feasible within the next two years,"​ the analyst added.

Meanwhile, Tesco continues to grow ahead of the market, which has lifted its share to another record - 31.1 per cent for the 12 weeks to 21 May.

Asda has dug itself into the number two spot, with a 16.4 per cent share, despite speculation that Sainsbury's may take over in the run up to summer. Recent aggressive price cuts have helped lift the year-on-year growth rate to four per cent said TNS - the highest level for 16 months.

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