Associated British Foods PLC (LSE:ABF) confirming talks about a potential transaction involving its Allied Bakeries unit and rival Hovis would be welcomed by shareholders, though shares in the Primark owner fell on Tuesday.
Talks are with Hovis owner Endless, which is far from unexpected, as the FTSE 100 group had said in its interim results last week that it was examining options.
Analyst Clive Black at Shore Capital says the talks rekindle a recurring story about a potential merger between the second- and third-largest players in the market.
It "may create a basis for further rationalisation, concentration of production, and so better margins,"
Accumulated losses at Allied were put at around £750 million, and so Black said resolving the division’s drag on ABF’s performance would be welcomed by shareholders.
With Allied and Hovis jointly representing around 40% of the UK plant bread market, what the Competition & Markets Authority may make of matters remains to be seen," he added.
"Allied has not only been a perennial challenge for ABF, it has also been a highly costly one, and so a better solution should be welcomed by shareholders."
Anubhav Malhotra at Panmure Liberum says a "potential merger of equals could unlock significant cost efficiencies necessary for the turnaround of both businesses" but agrees that a transaction between the "would likely attract regulatory scrutiny".
But he views such a deal as "being in the long-term interests of all stakeholders, as both companies may struggle to remain viable independently".
Both analysts noted the longstanding challenges in the UK bread sector, with Allied currently estimated to be generating around £400 million in annual sales but losing approximately £30 million.
Malhotra suggested that while a combined market share of the two brands could raise regulatory concerns, a merger of two loss-making businesses may support clearance with certain remedies.
Black said the UK market for plant bread, ie pre-packaged, mass-produced bread made in large industrial plants, has been "oversupplied for some years, reflecting a moderation in household consumption for the product alongside alternative morning goods lines such as patisserie alternatives and crumpets".
Current industry leader is family-owned Warburtons, while there are strong private-label operators like Fine Lady.
Hovis and Kingsmill, the latter Allied’s key brand, have been caught in the middle of an industrywide market share and margin squeeze, and it has been suggested in the trade that the two may have been exploring an amalgamation for some time now.