Should Tesco PLC And J Sainsbury plc Give Up Selling Groceries?

Like millions of Britons, grocery chain J Sainsbury (LSE: SBRY) hit the sales straight after Christmas, making a £1bn approach for Home Retail Group, the parent company of Argos, Habitat and Homebase. That’s quite an ambitious shopping list for £1bn. Too ambitious, perhaps, as its advances were rejected.

Grocery agony

It isn’t hard to see what Sainsbury’s is up to here. Margins in the grocery sector are being squeezed until the pips squeak, as Lidl and Aldi discount their way to ever greater market share. Sainsbury’s has defied the challenge better than most, being the only top four supermarket to boost share in the fourth quarter, helped by its relatively upmarket position. But the cut-throat supermarket price war has cost it blood and treasure, forcing its operating margins down to a squeaky 0.3%, according to Digital Look, and there’s no let-up in sight.

With future profits imperilled in this way, no wonder chief executive Mike Coupe is seeking some extra sizzle. But haven’t supermarkets been here before? During its heyday, Tesco (LSE: TSCO) sold just about everything in its vast warehouse Extra stores, piling up TVs, toys, home electronics, books, clothes and whatnot alongside the food, as it aimed to replace the high street. Isn’t this rather too similar to the Argos concessions that Sainsbury’s has been piloting in several of its stores?

Clarke’s commandos

Doomed chief executive Philip Clarke retreated from that strategy after admitting defeat in the price war against Amazon. He then pinned his hopes on other forms of diversification. In his attempt to make Tesco the family destination he bolted-on family-friendly restaurant chain Giraffe and artisan coffee chain Harris+Hoole, the latter of which is now on life support after posting £25.6m of pre-tax losses in the year to March 2015. This strategy is a distraction at best, as new boss Dave Lewis sinks his teeth into far bigger problems.

Sainsbury’s and Tesco are first and foremost grocers, and past attempts to diversify inspire little confidence. I can’t get too excited by the Home Retail bid either. Presumably, Sainsbury’s rates its link-up with Argos as a success and wants to pursue further cost savings, efficiencies and markets. The problem is that the challenges have rather uncomfortable echoes. Argos has also been squeezed by foreign competition, in the shape of all-conquering behemoth Amazon.

The big prize is the Argos online delivery service, which has been beefed up to compete with Amazon and would help Sainsbury’s boost its drive to increase higher-margin non-food sales. If Coupe did succeed in its bid, he would have tough decisions to make, such as what to do with the 800 Argos stores still scattered about the country. Diehard Argos customers continue to snub the digital revolution and buy from its weighty catalogues, and Sainsbury’s wouldn’t want to lose them.

You can see why Coupe wants to escape skinny food margins, but to make a success of diversification he really has to know its onions.

Growth prospects for both these grocers look limited but there are far more exciting opportunities out there.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.