Supermarket Sainsbury’s (SBRY) reported third-quarter results for the 15 weeks to January 5, with group sales excluding fuel down 1.1%, lower than analysts' full-year forecasts.
Management reaffirmed full-year guidance on cost savings of £200 million but didn't provide profit guidance; in the previous quarter, it said it was on track to deliver the current market consensus of £634 million in profits versus £630 million in Morningstar’s model.
Although sales growth disappointed, and it seems that there is considerable pressure in margins due to general merchandise weakness and down-trading by consumers, we maintain our £3.60 fair value estimate, £2.56 excluding the Asda deal, and no-moat rating. This makes the stock undervalued at the current share price.
Our valuation implies a 75% probability of a positive Competition and Markets Authority decision on the merger, reflecting uncertainty regarding the regulator's potential store disposal demands. The release validates our long-standing thesis on Sainsbury’s.
Excluding the potential benefits from a successful Asda acquisition, we think Sainsbury continues to be less prepared to face the fierce competitive environment in the UK grocery market.
What Sainsbury’s Must Do
Our stand-alone Sainsbury’s thesis is intact: first on the need to continue to invest more heavily back into the business to improve its pricing position relative to its big four peers, and second on the Argos deal, which we believe will not benefit the supermarket’s core grocery offering in terms of traffic and volume.
Rather, it will add to top- and bottom-line cyclicality in a soon-to-be post-Brexit world. In the third quarter, grocery sales ticked up 0.4%, versus 0.6% for Morrison (MRW) in the Christmas trading period, with positive volume according to management supported by the company's price investments in the previous quarters and healthy growth in online and convenience; 6% and 3% respectively.
In other categories, clothing outperformed a mostly declining market with sales sliding 0.2%. General merchandise was down 2.3% with margins remaining under pressure on the back of unfavourable mix and a highly promotional market environment.
Brexit Uncertainty Weighs
Other reasons cited by management were uncertainty due to Brexit, with a noticeable trade-down trend by customers, and reduced promotional activity across Black Friday. Sainsbury noted that 20% of the Argos stores generated like-for-like growth of more than 10%, implying negative like-for-like sales growth for legacy Argos stores given declining general merchandise sales growth.
Cost savings achieved for the half were £121 million, with the rest of the savings to be realized in the second half of the year. The guidance that was given previously but not mentioned in this release is the £500 million of cost savings expected by fiscal 2021 and £100 million net debt reduction in fiscal 2019. Argos synergies and cost savings; £200 million in fiscal 2019 and £300 million thereafter by fiscal 2021, should support profitability shorter term.
We think that for Sainsbury to compete effectively in this environment in the longer term, it would need larger scale that only the Asda deal can provide. CMA's preliminary decision on the proposed Sainsbury Asda merger is now expected in early February after the grocer's appeal for more time to respond to CMA's demands was admitted. CMA expects to issue its final report on the case in March.
Sainsbury will announce its preliminary results for fiscal 2019 on May 1.
