The Competition and Markets Authority said in a provisional report Wednesday that even giving up a large number of stores wouldn’t necessarily resolve its concerns. The regulator said the companies might have to sell off one of their two well-known corporate brands to win approval.

While the CMA has been mapping local areas across the U.K. as part of its in-depth probe, its initial view is that the loss of one of the Big Four supermarket chains will substantially cut competition at a national level. The enlarged group would rival Tesco Plc as the country’s largest grocer and has attracted considerable scrutiny from competitors, suppliers and politicians.

The report was “close to the worst possible outcome,” Sanford C. Bernstein Ltd. analyst Bruno Monteyne said in a note to clients.

The chains face a particular challenge in the market for online groceries to win over the CMA. It may not be possible to overcome competition concerns “without also divesting one or other of the Asda or Sainsbury’s brands,” the regulator said.

Sainsbury hit back at the report, saying the regulator had moved “the goalposts.”

“These findings fundamentally misunderstand how people shop in the U.K. today and the intensity of competition in the grocery market,” Sainsbury said in an emailed statement. “The CMA has moved the goalposts and its analysis is inconsistent with comparable cases.”

Shares of Sainsbury fell as much as 16%, the most since 2008. The ruling rattled shares throughout the U.K.’s grocery sector. Wm Morrison Supermarkets Plc, seen as a likely buyer for stores divested in the potential deal, fell as much as 5.3%, the most since November. Tesco Plc fell as much as 2.6%.

Local Markets

The regulator said in its provisional finding that the merger would hurt competition for grocery supplies nationally, specifically in 629 local areas where both Sainsbury and Asda operate supermarkets. That covers 45% of Sainsbury’s stores and 57% of Asda’s. Convenience store competition would also be affected in 65 areas, the CMA said.

“We have provisionally found that, should the two merge, shoppers could face higher prices, reduced quality and choice, and a poorer overall shopping experience across the U.K.,” Stuart McIntosh, who’s overseeing the CMA probe, said in a statement.

The regulator last week formally extended its deadline to investigate the deal, its biggest merger review in years, and now has until April 30 to make a final decision. The probe has taken in a rare court clash in December, where a judge ruled that the regulator had imposed excessively burdensome demands on the supermarket chains.