Tesco and Sainsbury resilient despite Asda's tough quarter

Citi analysts suggest Asda's recent challenging Q1 performance, marked by a 5.9% sales decline to £5.0 billion and a 35.7% drop in EBITDA to £164 million due to aggressive pricing strategies, poses no incremental risk to Tesco or Sainsbury. Despite Asda's net debt to EBITDA ratio increasing to 3.4 times and the company reducing prices on 12,000 product lines to maintain a price advantage, Tesco and Sainsbury shares remained stable in mid-afternoon trading, indicating market confidence in their resilience.

Analysis

Asda's first-quarter performance reveals significant challenges stemming from an aggressive pricing strategy, with total sales (excluding fuel) declining 5.9% to £5.0 billion and like-for-like sales falling 4.5% (3.1% Easter-adjusted). This follows a 4.2% drop in the prior quarter, indicating persistent top-line pressure. The company's EBITDA plummeted 35.7% year-on-year to £164 million, directly impacted by substantial price cuts across approximately 12,000 product lines, aimed at maintaining a 3-6% price advantage over competitors. This strategy has also led to a considerable increase in financial leverage, with Asda's net debt to EBITDA ratio rising to 3.4 times from 2.9 times in the previous quarter. Despite these pressures, Asda achieved modest gross margin improvements in its George clothing brand (up 50 basis points, sales +1.8% or +3.5% Easter-adjusted) and General Merchandise (up 20 basis points, sales -3.5% or -1.6% Easter-adjusted). Importantly, Citi analysts perceive no incremental risk to competitors Tesco PLC and J Sainsbury PLC from Asda's difficulties. This assessment appears to be shared by the market, as Tesco and Sainsbury shares remained largely unchanged following the Asda update, suggesting investor confidence in their resilience despite heightened scrutiny on UK supermarket pricing.

Key Decisions for Investors

• Investors in Tesco and Sainsbury may find reassurance in Citi's assessment that Asda's aggressive discounting and resultant financial strain do not currently pose an incremental threat to their market standing or financial performance.
• It is advisable to monitor the sustainability of Asda's price-cutting strategy and its elevated leverage, as any significant change in Asda's competitive posture or financial stability could influence the broader UK grocery market dynamics.
• Consider that while Tesco and Sainsbury appear resilient, ongoing intense price competition initiated by Asda, if sustained, could eventually necessitate a response that might impact sector-wide margins, warranting continued vigilance.