Exane BNP Paribas has downgraded its rating for Wm Morrison Supermarkets PLC (LON:MRW) to ‘neutral’ in the wake of the news of J Sainsbury’s (LON:SBRY) planned merger with Walmart Inc (NYSE:WMT)-owned Asda.
In a note to clients on the UK food retail sector, the French broker said it thinks Morrison’s could face more competition if the big merger goes through, although it believes the firm “could be considered a consolation prize”.
READ: Sainsbury's confirms £15bn Asda merger and dismisses reports stores will close
Exane’s analyst said the announcement that Sainsbury’s and Asda are in ‘advanced merger’ talks’ is “a big surprise.”
They added: “As always, we can the numbers to work in a spreadsheet and expect an initially positive reaction.”
However, the analysts continued, the risks – not just from competition authorities – are immense, so they recommend selling Sainsbury’s shares into any strength if the deal goes through.
They noted that grocery market leader Tesco PLC (LON:TSCO) - which earlier this year completed its own takeover of UK wholesaler Booker PLC - could have a tough competitor on its hands if the number two and number three biggest UK food retailers do merge, so it sees any deal as a negative for them.
The analysts said, however, that although the possibility of industry consolidation has been much discussed in the UK food retail sector, the conclusion has typically been that the Competition and Markets Authority (CMA) would either outright block a deal or else force so many remedies that it just wouldn’t be worthwhile.
READ: Sainsbury-Asda: Five reasons why this £14bn mega-merger was inevitable
They added: “Thought the CMA waved through the Tesco/Booker combination, we don’t see that as a good precedent and expect a touch time for ‘SASDA’.”
The analysts noted that if merger talks do reach an agreement, they expect that the deal could take at least a year to complete, creating a lot of uncertainty.
They added that the prospect of a counter bid might be there but Morrison’s now prides itself on disciplined capital allocation so it seems an unlikely suitor and Tesco seems too big.
The analysts concluded that a third party – private equity – bid might be possible but the probability seems low.
The Exane analysts cut their target price for Sainsbury’s by 4% to 250p, and reduced their target for Tesco by 2% to 180p.
They “only” downgraded Morrisons to ‘neutral’ from ‘overweight’ with an unchanged 250p price target
In late morning trading. Morrison’s shares on the FTSE 100 index were up 0.1% at 240.3p. The UK’s fourth biggest supermarket chain will issues a trading update on May 10.
Tesco shares were 1.0% lower at 235.8p, while Sainsbury’s shares soared 15% higher to 310.6p.