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Is the Sainsbury share price rise sustainable after this latest setback?

If you’re a player in a struggling sector, it doesn’t help if you have a significantly smaller share than the market leader. That’s the problem for J Sainsbury (LSE: SBRY), which has around 15% of the UK groceries market, according to Kantar Worldpanel.

That’s some way behind Tesco‘s 27%. But the combined 30% of the market that would be commanded by the planned merger of Sainsbury with Asda would catapult it to the top of the leaderboard.

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Competition fears

But now the Competition and Markets Authority (CMA) has decided to refer the proposed deal for a further “in-depth investigation.” The CMA says that two have overlapping stores in “hundreds of local areas, where shoppers could face higher prices or worse quality of service,” and there’s also a fear of excessive buyer power over suppliers.

One possible outcome of the more intense scrutiny is that stores across the UK could be forced to close, with some speculation suggesting as many as 300 might have to be sold off. But that would still leave the merged company with around the same market share as Tesco.

The markets don’t seem fazed by the latest developments, with the Sainsbury share price hardly changed at 319p as I write. But what does it all mean for investors?

Good investment?

I remain convinced that the Asda merger would be a good deal for Sainsbury shareholders. But I have to qualify that by saying I simply wouldn’t invest in the sector at all. The reason is that, increasingly, I see no real differentiation between the big players. It’s a market were the goods are just as good whoever you get them from, and competition is almost solely on price.

That’s great for shoppers (and I love Aldi which has opened two stores near me – I never visit my local Tesco or Sainsbury now). But it’s really not good news for investors.

Tesco’s latest response to the onslaught from Lidl and Aldi (who have already grabbed a combined 13% market share) is its low-cost Jack’s outlets, but I can’t help thinking that’s missing the point. Increasingly, shoppers simply want good products at the cheapest prices. We don’t want a low-cost chain plus the option of going somewhere else instead and paying more for essentially the same stuff.

No bargains

I also see supermarket shares as overpriced. Sainsbury shares are on a forward P/E of more than 15, Tesco is slightly higher on current forecasts, and Wm Morrison shares are even more expensive on a P/E of around 18. That’s in a business that is offering dividend yields of around 3% (which is lower than the current FTSE 100 forecast average of 4.1%), and is among the most competitive we have.

I can’t help seeing the CMA’s fears of reduced competition as overblown and I’d be surprised if the merger isn’t ultimately given the nod. But none of my investment money is going anywhere near the sector.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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