It’s Tesco’s chance to turn screw on PE

It’s time for Britain’s largest retailer to start the mother of all price wars. Tesco Plc has the perfect opportunity to slash prices on everything from milk to mushrooms — and lure customers away from competitors.
With one big rival, Asda Group Ltd, in private equity hands, and a second, Wm Morrison Supermarkets Plc, potentially following suit, Tesco CEO Ken Murphy suddenly has more freedom to take risks and craft a bold new strategy.
By lowering costs for consumers, he can put pressure on debt-laden private equity-owned grocers, which can’t cut prices as easily, as well as listed rival J Sainsbury Plc, which historically had the weakest finances in the sector, although it’s now making strides to bolster its balance sheet.
Tesco has managed to weather the greatest crisis in its more than 100 year history — a 250 million-pound ($345 million) profit overstatement that it announced in September 2014. Total debt, including store leases and the pension deficit, ballooned to 22 billion pounds by February 2015. Six years later, as of February 2021, this had fallen to 13 billion pounds.
The supermarket is also raking in cash. Even in the pandemic year, it generated 1.2 billion pounds of retail cash flow.
Tesco could easily use some that to cut prices. Former CEO Dave Lewis (belatedly) made the company more competitive by introducing a series of cheaper brands and matching German discounter Aldi on hundreds of products in March 2020. These moves have helped lift sales.
But the relatively new Murphy should go further. After all, Tesco is still the UK’s biggest supermarket, with a 27% market share. That should allow it to get the best deals from suppliers and generate economies of scale. He’s already proven capable of using Tesco’s considerable clout to his advantage: In December, the company said it would repay 585 million pounds of business rates relief. By forgoing the tax break, it forced the rest of the big four UK grocers — Asda, Sainsbury and Morrison — to fall in line behind it.
Murphy is well poised now to repeat the trick and take a broad ax to prices — beyond the Aldi price match and targeted promotions for members of its Clubcard loyalty program. With billions of pounds worth of borrowings that need to be repaid to make their required returns, private equity-owned rivals may have less financial firepower to make similar cuts.
What’s more, Asda CEO Roger Burnley will leave next year, and the group is currently searching for a successor. The incoming CEO will need time to develop his or her strategy, potentially making it slower to respond.
To be sure, starting a price war carries risks.
The big four supermarkets aren’t just fighting amongst themselves anymore. Aldi and Lidl now have a combined market share equivalent to that of Asda. Both have a strategy to not get beaten on price. Where Tesco goes, they may well follow.
It’s also possible that away from the glare of quarterly reporting, and without the requirement to pay dividends to shareholders, Asda (previously owned 100% by Walmart Inc) and Morrison could dedicate more resources to offering discounts. Morrison, for example, has paid out and
declared dividends worth more than 1.8 billion pounds since 2015, so it’s pretty cash generative too.
But even the most patient private equity owners will have to make a return on their investment sooner or later.

—Bloomberg