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Sainsbury shares up over 10% in morning trading

Steve Clayton | 30 September 2015 | A A A
Sainsbury shares up over 10% in morning trading

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Sainsbury (J) plc Ordinary 28,4/7p

Sell: 190.50 | Buy: 190.70 | Change -1.90 (-0.99%)
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Sainsbury shares have jumped over 10% in early morning trades as they revealed an improvement in trading performance in their second quarter. Excluding the impact of falling fuel prices, total sales were up 0.3%, with the Like-for-like (LFL) number showing a fall of 1.1%, somewhat better than seen in previous quarters. Volumes and transactions grew, offset by food price deflation and a continuing, but lessening, fall in average basket size.

A shift to a less promotional stance, with lower everyday prices is assisting Sainsbury to forecast demand for items more accurately, which is reducing waste in fresh foods, improving availability and freshness. The programme to enhance the quality of 3,000 own brand products is on track and Taste the Difference sales rose by 4%, picking up the Good Housekeeping award for best supermarket range for a third year running. No doubt much to Tesco's chagrin, for they will clearly have thought theirs was the Finest.

Ahead of the new National Living Wage introduction, Sainsbury announced a 4% pay rise for store colleagues. It speaks volumes about the state of wage growth in the economy generally, that this was the highest increase in a decade.

Twenty seven new convenience stores opened, and online sales grew by 15%, whilst the launch of the Tu clothing range online was said to have significantly exceeded expectations. Clothing grew 13% in the quarter, largely it seems, due to 640,000 small boys going back to school in Sainsbury's school trousers.

Overall, Sainsbury say they have traded well, and both sales and cost savings have come in ahead of their expectations, leading to an expectation that full year underlying profit before tax will now be ahead of the published consensus expectation of £548m.

Our view:

The second quarter trading statement is the first undeniably positive news from a Big4 supermarket operator in years. Sainsbury may not have escaped unbloodied from the supermarket wars of recent years, but they look to be in much better shape than their main rivals.

Price Match kept them competitive at the till, even if they look to be more expensive than rivals at the shelf edge, though obviously there is a real gap still between them and the discounters. Now, their move toward lower everyday prices, with fewer promotions is improving availability, freshness and sales.

Asda's own Income Tracker survey has recently been showing a useful rise in households' discretionary spending power, as rising employment and lower fuel prices feed into incomes. That could provide some respite for Sainsbury and its peers if people choose to spend the extra money in the aisles.

Profits are now expected to come in "moderately ahead" of the £548m consensus. Before we get too excited, we should remember that the company reported profits of almost £900m in FY2014. But, things have, at least for the moment, stopped getting worse, and that matters a lot. The forecasts for FY2016 might not move that much; Sainsbury did only say "moderately ahead", but clearly if trading continues to improve, there is more scope for movement in the years further out. Ahead of this trading statement, consensus had little profit growth expected as far out as 2018.

There are a lot of moving parts here. The core supermarkets are going to continue losing sales to Convenience and online, because of changing shopper behaviour, before we even consider what the competition might get up to. The Bank is a source of upside, but only once the costs of setting it up properly are back under control.

Free cash flow should improve from here, due to the lower capex plans. A lower dividend bill helps too. Analysts were expecting Sainsbury to generate EBITDA of about £1,200m per annum for the next few years. Take off £200m or so for the dividend, about the same again for tax and £450m for capex and there is still quite a lot of cash left over, so debts ought to fall quite quickly.

If trading continues on its new, positive trajectory, then eventually, that cash might head toward shareholders. In the meantime, sticking to the dividend cover target of 2.0x suggests that the stock might yield around 4%, given that analysts were pencilling in earnings per share of 20-24p for the current year , even before the news of the upgraded trading performance although there are no guarantees.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.