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Sainsbury - Transaction numbers up but deflation still a headwind

George Salmon | 28 September 2016 | A A A
Sainsbury - Transaction numbers up but deflation still a headwind

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

Sell: 209.90 | Buy: 210.10 | Change -2.40 (-1.13%)
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Our View

Following the completion of the £1.4bn acquisition of Home Retail, the big issue for Sainsbury just now is the integration of Argos. With over £4bn of sales in 2015, Argos offers Sainsbury the chance to significantly increase its exposure to non-food markets. Investors will hope that setting up Argos concessions within larger stores will simultaneously drive footfall and solve any excess sales space problems. Hopes will be high after the performance of 10 trial concessions was sufficient for Sainsbury to press on with the deal.

Sainsbury are seeking to achieve around £75m of synergies from these space-saving concessions, as part of total savings of £160m p.a. Integrating Argos' delivery network could also benefit Sainsbury's online offering. Sainsbury's Bank can refinance Argos' loan book to release around £800m, so the cash cost of the takeover is minimal.

On paper then, the deal looks reasonable. However, as things stand, both businesses have longer-standing problems to deal with. Home Retail has struggled to compete with the likes of Amazon, while Sainsbury, like all of the large UK supermarkets, has come under pressure from price deflation. The rise of Lidl and Aldi means that its superstores in particular are struggling. With no net new openings so far this year, expansion of the larger stores has been stopped in its tracks.

Sainsbury's CEO Mike Coupe can clearly see the challenge presented by the deal, and has described it as a career defining moment. It remains to be seen whether his multi-product, multi-channel strategy will turn two negatives into a positive. If it does, it will be a masterstroke.

In the meantime, the shares offer a prospective yield of 4% and are on a PE of c. 12x.

Trading update

Sainsbury this morning released a trading update for the second quarter of its financial year, the 16 weeks to 24 September 2016. The shares moved 0.5% higher on the news.

Excluding fuel, total retail sales are down by 0.4% in the quarter, while like-for-like (LFL) retail sales are again negative, down by 1.1%. However, transaction volumes are up. Sainsbury are selling more items, but at lower prices.

As food price deflation continues, the strategy of lowering the prices of everyday products will continue, while multi-buy promotions are phased out.

Online and convenience stores continue to outperform Sainsbury's superstores, with Groceries Online delivering 8% sales growth and convenience business increasing by almost 7%. Within Sainsbury stores, non-food General Merchandise sales grew by 4%.

Following the acquisition of Argos owner Home Retail, Sainsbury confirm that in Argos' second quarter, to 27 August, total sales increased by 3% with 2.3% LFL growth. Sainsbury plan to open another 15 Argos Digital stores in Sainsbury shops, giving a total of 30 open by Christmas.

Looking forward, Sainsbury CEO Mike Coupe said "we expect the market to remain competitive and the effect of the devaluation of sterling remains unclear. However, Sainsbury's is well positioned to navigate the changing marketplace and we are confident that our strategy will enable us to continue to outperform our major peers."

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.