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Sainsbury - Strong full year results, and Asda deal announced

George Salmon | 30 April 2018 | A A A
Sainsbury - Strong full year results, and Asda deal announced

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

Sell: 202.30 | Buy: 202.50 | Change 0.40 (0.20%)
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30 April was a busy morning at Sainsbury.

The group announced full year results, which saw the full year dividend held at 10.2p per share, and also detailed its merger plans with Asda, which is currently owned by Walmart.

The shares rose 16.5% in early morning trading.

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Our View

The proposed tie-up with Asda is a reflection of the forces at play within the UK grocery market.

Sainsbury sits somewhere in the middle of the value chain. Being in the centre ground has its advantages, but in recent years these have been outweighed by increased pressure from rivals both above and below. The entrance of Aldi and Lidl has increased the emphasis on pricing, while the rise of more upmarket offerings like M&S Food and Ocado bring unwanted extra competition from the top end.

All this has made for challenging times. Market share has fallen to 15.8%, and with margins dropping too, profitability has followed suit.

Sainsbury clearly feels its best chance of combatting these difficulties is to take on extra scale through a merger with Asda. The most obvious benefit is increased buying power. £51bn of annual sales should mean the enlarged group can renegotiate terms with suppliers. There's potential for logistical savings too.

It's not just costs that can be improved either. The combination would allow Sainsbury to apply its impressive delivery network to bolster Asda's appeal. Argos concessions have performed well in Sainsbury's stores, and Asda might be an even more natural fit.

For all its attraction, the deal shouldn't be thought of as a 2 for 1 special offer. Operating profits have been trending down at both groups, and turning two negatives into a positive is never a formality - especially since rivals could respond with more price cuts.

The deal will push up net debt relative to EBITDA and this clearly brings some extra risk. However, the Asda pension scheme is staying with Walmart, and much of its store estate is owned rather than leased. Lower leasing obligations should mean there's plenty of cash left over to pay down the debt.

The combination also needs the thumbs up from the competition authorities. Combining the sector's second and third biggest players will raise an eyebrow, but the rise of the discounters means there's competition outside the established big four. That should help alleviate some concerns.

There's clear upside potential if the deal goes ahead. The impressive work on integrating Argos will reassure investors Sainsbury can pull it off, but this is still a significantly bigger operation.

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Asda deal

The merger between Asda and Sainsbury values Asda at around £7.3bn.

Pending shareholder and regulatory approval, Sainsbury is set to pay £3bn in cash, and issue shares to Walmart such that the US retail giant will hold 42% of the combined business. Sainsbury expects the deal to complete in the second half of 2019.

The group plans to maintain both the Sainsbury's and Asda brands. Currently, the two have over 2,800 stores in the UK and Ireland, with combined revenues of £51bn.

Sainsbury says it will be able to lower prices by c.10% on many of the products customers buy regularly. Even after this price investment, the group expects to generate cost and revenue efficiencies of £500m.

Full year results (52 weeks to 10 March 2018)

Full year revenues and profits were slightly ahead of analyst expectations.

Revenue, excluding fuel, rose 8.5% to £28.5bn, driven by the acquisition of Argos and the addition of new space. On a like-for-like (LFL) basis, sales rose 1.3%, with LFL sales in the fourth quarter up 0.9%.

Retail operating margins dipped 0.18 percentage points to 2.24%, impacted by the addition of lower margin Argos sales.

However, the effective integration of Argos, plus better than expected cost savings of £540m, ensured underlying operating profits were still marginally ahead of last year, at £694m. Retail profits were £625m, with £69m from Sainsbury's bank.

Within Retail, Grocery sales were up 2.3%, driven by convenience and online, where sales rose nearly 8% and nearly 7% respectively.

Elsewhere, Clothing sales rose 3.8%, with General Merchandise sales dropping 0.8%. However both were ahead of the market, and so gained market share.

Improved free cash flow of £432m helped net debt fall by £113m to £1.9bn.

Looking ahead, the group believes it is well-placed to navigate a challenging external environment, and has committed a further £150m to lowering the price of 930 essential items. Management expect underlying pre-tax profits of around £629m this year.

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