'Primed' for Amazon? Consolidation in UK grocery market and its impact on supermarket stocks

German discount supermarkets Aldi and Lidl have upended the UK grocery market in the past years. The discounters are expected to increase their market share from 12.1% currently to 15% by 2020. Aldi aims to have 1,000 UK stores by 2022 up from 762 currently while Lidl forecasts a potential of 1,200 to 1,500 stores in the long-term. Lidl has 710 stores currently.

To better compete with the discounters, the big four supermarkets Tesco (LON: TSCO), Sainsbury (LON: SBRY), Asda and Morrisons (LON: MRW) have embarked on cost-cutting sprees shutting down stores and restructuring store management.

The battle for market share is happening in a phase of consolidation with Tesco's acquisition of wholesale operator Booker. Now months after acquiring Argos, Sainsbury's has entered into a mammoth deal to acquire Asda creating a grocery powerhouse that will take overtake Tesco as the market leader, provided it meets regulatory apporval.

Assuming the merger goes through, the combined company would have 2,800 stores across the UK with combined revenues of £51bn and operating savings of £500m. The impact on suppliers is one of the issues the regulator - CMA (Competition and Markets Authority) - will be looking at closely. 

Some experts believe that the CMA will order 75 stores to be disposed while others have forecast the number to go up to 245 disposals. There is thus a long way to go before details are finalised.

The two supermarkets would give the combined company a market share of 32% to Tesco’s share of 28%. According to Sainsbury, the grocers use the same 100 suppliers for 85% of their products and thus £350m of savings will be generated through price harmonisation. A further £75m will come from integrating Argos outlets into Asda stores. Asda and Argos customers have similar demographics and thus the merger will see benefits extend beyond the grocery division. 

Price wars thus will inevitably continue but the sun has also not set on further consolidation in the sector. Amazon (NASDAQ:AMZN) was rumored to have approached John Lewis to take over its Waitrose supermarket chain. In addition, Amazon’s partnership with Morrisons to provide deliveries to UK customers using Pantry and Prime services makes the UK supermarket a potential target.

Marks & Spencer (LON: MKS) is another prospect. The company’s share price has fallen by nearly a quarter in the past year due to disappointing sales in clothing and food. The M&S brand name could further accelerate Amazon’s push into fashion retail. Given Amazon's sheer size, it could also acquire Tesco but this is less likely given it is currently digesting Whole Foods into its current structure.  

Though the Sainsbury-Asda merger would trigger a set of new price wars and thus press margins down further, Tesco and Morrisons’ investors should not be too hasty to drop their shares given the likely arduous regulatory process. With Ocado (LON: OCDO) overtaking M&S in market cap, online is the key battleground that will help determine future success. 

Given that UK supermarket stocks are all near their 52-week highs and consumers are tightening their wallets in search of bargains, it is likely not the ideal time to buy such stocks. However, Amazon's next move could make things really interesting.