Since Monday's announcement from J Sainsbury (LSE: SBRY) that it proposes to combine its business with Walmart's Asda, the shares remain elevated. As I write, the stock has slipped back around 3% after shooting up almost 17% higher than Friday's closing price on the news.
Even now, at 306p or so, the stock changes hands at levels last seen during the summer of 2014 - I think it's fair to say that the news excited the investment community, but is the proposal a good deal?
A dynamic new player?
The Combined Business will, in the positive-sounding words of the news release, "create a dynamic new player in UK retail with an outstanding breadth of products, delivered through multiple channels." The rationale presented has it that enhanced scale and a stronger balance sheet will "deliver a great deal for customers, colleagues, suppliers and shareholders of both businesses."
However, I can't help but be cynical about this. Nineteen years ago, Walmart swept in and took over Asda. Back then, the firm presumably had high hopes that it alone would "create a dynamic new player in UK retail with an outstanding breadth of products etc." Many watched in full expectation that the mighty Walmart would sweep Britain's bloated Tesco aside to win dominance on our islands. Yet, Monday's news looks more like Walmart throwing in the towel with a tacit admission that the British market is just too hard a nut to crack. Perhaps grocery businesses don't travel across the Atlantic very well in either direction.
In fairness, trading conditions have been brutal for all the big, long-established supermarket players in the UK. Monday's news release tells us that the retail sector is going through "significant and rapid change, as customer shopping habits continue to evolve." Too right. The big supermarket firms in Britain had it too good for too long, in my opinion, and they seemed to become complacent about the way they were treating their customers and suppliers in many different little ways. I'm not surprised to see cash-strapped consumers embracing a wave of price-cutting competitor enterprises led by the likes of Aldi and Lidl, and shopping around for better-value clothing and general merchandise as well.
Sainsbury thinks that its combination with Asda will "result in a more competitive and more resilient business that will be better able to invest in price, quality, range and the technology to create more flexible ways for customers to shop." I'm not so sure that going 'large' is such a good way to compete in the longer term. If the deal goes through, the combined business, based on 2017 revenues of £51bn, will be on par with Tesco, which turned over around £56bn.
But I think, in the teeth of the gathering headwinds whipped up by upcoming, big-discounting competition, the best tactic could be to bend. So managed contraction looks like an attractive option to me, not rapid expansion. An industry with wafer-thin margins, high volume turnover and fierce competition is not attractive. So, if I'd been holding Sainsbury shares I'd be selling out now. Perhaps singing as I go, "I'm in the money..."
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.