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Sainsbury - Argos impressing, but conditions remain difficult

George Salmon | 3 May 2017 | A A A
Sainsbury - Argos impressing, but conditions remain difficult

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

Sell: 201.80 | Buy: 201.90 | Change -0.20 (-0.10%)
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Sainsbury's full year results show a 12.7% increase in group sales, driven by the impact of bringing Argos into the group. On a like-for-like (LFL) basis, Sainsbury sales declined 0.6%, with market share falling 0.23 percentage points, despite its investment in pricing and transaction numbers growing.

Despite the positive contribution from Argos, group underlying profit before tax fell 1% to £581m as retail conditions remain difficult. The shares dipped 2.4% on the news.

Our View

When the Argos deal was announced, both businesses were struggling. We said that if CEO Mike Coupe could turn these two negatives into a positive, it would be a masterstroke. Early signs suggest he's getting there with Argos, but much work lies ahead for the grocery business.

In its last update as part of the Home Retail Group, Argos delivered like-for-like growth of just 0.1%. In May's full year results, sales growth topped 4%. There are already 59 Argos stores in Sainsbury supermarkets, and results have been particularly encouraging from the store-within-a-store format. A total of 250 Argos Digital stores are set to pop up in the bigger superstores within the next 2 years.

The deal eats up some excess sales space, and there is always the chance footfall might improve as awareness grows of where Argos stores have disappeared to. However, in reality we feel it's unlikely to have such a transformative impact on the core business.

With grocery still very much the senior partner, this is where the problem lies for investors just now. While like-for-like trends improved slightly through the second half of the year, Sainsbury's superstores are still struggling. The deflationary pressures that have dogged the industry might be easing a touch, but this isn't because competitive pressures are going away, rather that sterling's weakness raises the cost of imported goods.

The discounters keep marching on, and with traditional UK rivals unlikely to take a backwards step, it's hard to see how both revenue and margins could be improved by engaging in a straight up slugging match. Sainsbury is instead trying to box clever. The group is trying to differentiate itself by delivering a demonstrably better service from non-traditional means like online and Click & Collect. This seems like a sensible approach, but conditions clearly remain challenging.

At present the shares offer a prospective yield of 3.6%, and trade at 14 times expected earnings.

Full year results

Sainsbury describes the retail environment as competitive and uncertain. In line with these difficult conditions, Retail underlying operating profit fell 1.4% to £626m, despite cost savings of £130m and a contribution from Argos of £77m. Retail underlying operating margin declined 0.32 percentage points to 2.42%.

The source of the decline continues to be larger supermarkets, with sales down 2% even after opening 6 new stores. The group say this is symptomatic of changing consumer habits. More flexible shopping options continue to prove popular, with convenience sales up by over 6% and groceries online by 8%. Over the year, Sainsbury invested in its first purpose-built online fulfilment centre in Bromley-by-Bow and opened 41 new convenience stores. Click & Collect is growing too, while Sainsbury is trialling one-hour delivery to over 40,000 London postcodes.

Argos sales grew 4.1%, with 53% of group wide general merchandise and clothing sales now made online. Mobile participation also grew 60% this year. The group is confident of delivering its £160 million EBITDA synergy target from Argos acquisition by March 2019, six months ahead of plan.

Sainsbury's Bank (including Argos Financial Services) delivered an underlying operating profit of £62m. This was down nearly five per cent due to the impact of reduced interchange fees and investment required to enter the mortgage market.

The final dividend is set to be 6.6p per share, making a full year dividend of 10.2p (2015/16: 12.1p). This is covered two times by underlying earnings, in line with Sainsbury's policy to pay an affordable dividend. Net debt fell by £349m to £1.5bn.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

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.