We are raising our fair value estimate for Sainsburys (SBRY) to £2.80 per share from £2.70, largely due to the time value of money. Our assumptions for same-store sales growth and profitability have the largest impact on our fair value estimate, and given the intense competition in the U.K. grocery market, we assign Sainsbury a medium uncertainty rating.
Acquiring Argos could help Sainsbury bolster its competitive position in an era of e-commerce
If industry players undertake even more aggressive pricing strategies than we anticipate in our base case, it could be difficult for Sainsbury to increase prices in line with inflation over the long run. Competitive pricing activity could be more pronounced and last longer than we assume in our base case, especially if economic conditions in the U.K. worsen over the near term.
Based on Sainsbury’s offer to purchase Argos for about £1.2 billion, the firm’s updated forecast for £160 million in run-rate synergies, versus £120 million previously, makes the deal slightly accretive, but only by a rounding error. The firm’s updated synergy estimates come from higher rent concessions, Sainsbury will move many stand-alone Argos stores into its own stores, and cost synergies, partially offset by lower estimates for cross-sale synergies. We believe that these cost estimates are reasonable, and believe that Sainsbury should be able to realise at least £145 million in total synergies.
However, the firm’s £15 million in revenue synergies is uncertain. Sainsbury’s assumptions call for zero loss in Argos sales for relocated Argos stores that are currently located less than a mile away from Sainsbury’s stores. We think that this assumption is reasonable, but note that Sainsbury’s acquisition would be value-neutral with an assumption of no revenue benefits over the long term.
Of course, the impact of acquiring Argos could help Sainsbury bolster its competitive position in an era of e-commerce, as Sainsbury will be uniquely positioned to sell general merchandise products in the online channel. This acquisition, by itself may not change much in terms of Sainsbury’s distribution costs, as the firm expects to run the supply chains independently. However, to the extent that Sainsbury can drive incremental traffic, its per-unit store operating costs could decrease.
