Sainsbury's new boy has low prices stacked against him

Lack of discounting firepower will make it difficult for Justin King to take on rivals
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It's a bank holiday: the wind may be brisk, the clouds may be grey, but Asda's optimism shone through yesterday when the supermarket group attempted to kick-start the barbecue season by dropping the cost of a cast-iron BBQ to £10.97 from £12.97.

And the self-styled "consumers' champion" didn't stop there. Bank holidaymakers seeking to make the most of a break in the rain may like to know they can pick up a set of outdoor furniture plus parasol from the supermarket chain for a shade under £80, some 15 per cent less than it was. Fed up with burnt bangers? Try grilling fresh salmon - a steal at £2.98 a kilo, down from £4.38.

These headline-grabbing price cuts represent just the latest salvo in an escalating supermarket price war that was triggered when the Government barred all but Wm Morrison from acquiring the super laggard Safeway. Asda, which has been part of the biggest retailing family in the world since being swallowed by Wal-Mart five years ago, yesterday announced it would spend £65m on lowering its prices "across the board". The move, orchestrated by Asda's trading and marketing director, Angela Spindler, spans the range from PG Tips tea to Shiraz red wine and means Asda has spent £175m on reducing prices so far this year, reinforcing its reputation as the cheapest place to shop [see table, bottom left].

Coming just two days after Morrison's own attempt at PR - it put a basket of products on display that cost 24 per cent less than Safeway used to charge - Asda's announcement serves to highlight the extent of the battle that is raging to win the hearts, minds and wallets of UK shoppers. "The ante has been upped," said one food retail analyst of Asda's attack.

With Morrison committed to lowering Safeway's prices by 6 per cent throughout the store by the autumn, and Tesco well equipped to follow suit, there was but one question on the lips of City analysts yesterday: where does this leave J Sainsbury?

As the latest market share figures from researcher TNS reveal, Sainsbury's would need more than a few cut-price BBQs to find salvation. Of the new Big Four in the food retailing sector, Sainsbury's fared the worst during the past three months, even after adding back Safeway's drag to Morrison's own performance. Sainsbury's market share grew by just 1 per cent in the 12 weeks to 28 March, against a 3 per cent gain at a combined Morrisons/Safeway, a 10 per cent improvement at Asda and an 11 per cent increase at Tesco.

More worryingly, on a one-month basis, analysts at JP Morgan note that Sainsbury's growth slumped from 3.1 per cent to minus 1.1 per cent. Which leads them to add that it "may not be so long" before Sainsbury's suffers the further ignominy of slipping behind Morrison in terms of market share. With the latter growing its market share at the same rate as Asda, they predict Morrison's 14.6 per cent will soon overtake Sainsbury's 15.7 per cent, relegating the former darling of the British housewife to fourth place in the food retailing league.

To justify their gloom, Analysts point to Sainsbury's shocking fourth-quarter figures, which saw Sir Peter Davis bow out as chief executive of the group he was hired to rescue with a profit warning. Despite putting its internal restructuring programme on hold, and stepping up its own price investments, Sainsbury's reported a 0.9 per cent fall in its like-for-like sales - a full percentage point lower than it managed over Christmas. In running just to stand still, the group ceded 50 basis points of margin - and this before its new boss, Justin King, attempts to work his own Asda magic (he cut his supermarket milk teeth at the group under Allan Leighton and Archie Norman.

"All the supermarkets appear to be funding price cuts from efficiencies and scale. The only people who are getting smacked are Sainsbury's," one analyst said. "Without even going on to the front foot they have managed to lose 50 basis points of ebita [earnings before interest, tax and amortisation] margin in the second half. The boy [Justin King] has got his work cut out."

Mr King's attempt on day one to take on Tesco and Asda in the notoriously competitive world of Easter eggs showed he meant business. His three-for-£4 on chocolate eggs was £1 less than Sir Peter had charged and 50p less than the market leaders. But Mr King wound up with egg on his face after Tesco and Asda simply followed suit. "All that happened was the whole industry has lost its profitability on Easter eggs," said Paul Smiddy at Robert W Baird. "His inclination is to be aggressive but he doesn't have the firepower to do it."

Analysts were split yesterday on whether Asda, which pioneered the concept of everyday low pricing in Britain, would continue to lead the charge or be relegated to playing catch up as the might of Tesco increases. One said: "Asda is now on the back foot in terms of keeping the attention of the customer."

That Morrison's own-banner stores grew their market share by 14 per cent during the past three months, as customers piled in to check out what all the fuss was about, suggests this rings true. Yet predictably an Asda spokesman was vehement that it did not. "We anticipate making sure that there is clear blue water between us and our competitors. It is a very competitive market but we've led on price for quite some time and we are absolutely determined that we will not let that slip," the spokesman said.

With the gauntlet well and truly thrown down to Mr King, the City is struggling to see how he can respond. His first task will be to decide whether to reposition Sainsbury's away from its high-price-but-good-quality heritage.

JP Morgan's latest pricing survey found that Sainsbury's prices were about 7 per cent higher than Tesco's and almost 8 per cent above Asda's, a fact that doesn't seem to have escaped its customers. Analysts at Merrill Lynch have estimated that it would cost at least £650m for Sainsbury's to reduce its prices by 5 per cent - more money than it is expected to make next year before it has paid tax.

JP Morgan fears that launching a price war could do Sainsbury's more harm than good. "Even significant price cuts of 2 to 3 per cent would only reduce Sainsbury's differential with Tesco to 5 to 6 per cent," its food research team wrote in a recent note. "Is this enough to raise volumes significantly? Is it enough to change consumer perception of Sainsbury as a high-priced operator? We think not. Furthermore, owing to Sainsbury's high leverage we think any price cuts would have a significant impact on profitability."

Against a backdrop of food price deflation, fuelled by better buying power and general operational efficiencies, analysts believe supermarket profits are set to be squeezed. With 90 per cent of store portfolios competing against each other, they predict customers will prosper at investors' expense. At least if money gets tight, Sainsbury's shareholders can always start shopping at Asda.