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Sainsbury - Argos cost savings boost profits

Nicholas Hyett | 8 November 2018 | A A A
Sainsbury - Argos cost savings boost profits

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

Sell: 279.30 | Buy: 279.50 | Change 1.20 (0.43%)
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Retail sales rose 3.5% in the half to £16.9bn, with like-for-like (LFL) sales excluding fuel up 0.6%. Underlying profits before tax rose 20%, as synergies from the merger with Argos were delivered ahead of schedule.

The interim dividend remained unchanged at 3.1p per share.

The shares were broadly unmoved in early trading.

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Our view

Sainsbury sits somewhere in the middle of the value chain. The centre ground has advantages, but in recent years these have been outweighed by increased pressure from rivals above and below. Aldi and Lidl offer cheaper alternatives, while more upmarket offerings like M&S Food, Waitrose and Ocado have been growing too.

Market share has fallen to 15.4%, and margins and profits have followed suit. The deal with Asda is the group's solution. It has several eye-catching features, was taken well by the market.

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, on top of the £200m of savings expected from business as usual this year.

Sainsbury has pledged to pass a good deal of those savings into consumers though - more evidence that the price wars aren't over. But fortunately it's not just costs that can be improved. 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.

The ratio of debt to EBITDA would rise 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 lease obligations should mean there's cash left over to pay down the debt.

For all its attractions, the deal shouldn't be thought of as an unmissable 2 for 1 special offer.

Operating profits have been trending down at both groups until recently, and turning two negatives into a positive is never a formality - especially since rivals could respond with more price cuts.

Combining the sector's second and third biggest players will prompt a close look from the competition authorities too. On the bright side, geographic overlap isn't as bad as you might think, with Asda weighted to the North and Sainsbury the South. The rise of the discounters also means there's more to the sector than the established big four these days.

Nonetheless, there's every chance approval would come with some painful conditions attached. We'll be keeping a close eye on what the CMA has to say.

For now, the shares offer a prospective yield of 3.4%.

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Half Year Results

The improvement in Retail sales reflects good results from Grocery and General Merchandise, up 1.2% and 1.5% respectively, more than offsetting a 1% decline in Clothing sales. Online and convenience outperformed the superstore format, with sales up 4.3% and 6.9%.

The strong results were attributed to the good weather over the summer, boosting convenience stores and General Merchandise. The growth in LFL sales in across Retail was driven by a combination of continued price inflation and LFL transaction growth.

Opening new Argos stores in Sainsbury's resulted in a 127,000 sq. ft. reduction of Sainsbury Supermarket space, with 60 new Argos stores opening in Sainsbury's and 36 standalone stores closing. The group now has 233 Argos collection points in its stores.

Synergies from the acquisition of Argo reached £150m in the half, about nine months ahead of the original plan. Those cost savings meant underlying operating profit margin in the Retail business improved 0.36 percentage points to 2.25%.

Despite the grocery, general merchandise and clothing markets remaining highly competitive and very promotional, Sainsbury is on track to deliver full year profits in line with market consensus this year.

The group continues to wait for the Competition & Markets Authority to report on its proposed merger with Asda.

Net debt was dramatically lower ta the half year, however, this reflects the effects of timing will increase again by the year end. Full year net debt is expected to be £100m lower than last year at £1,364m.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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 for more information.