Sainsbury has confirmed falling clothing and general merchandise sales in the 15 weeks to 5 January offset slight growth in the core grocery division, leading total retail sales (excluding fuel) down 0.4%. On a like-for-like basis, that represents a slightly worse-than-expected 1.1% decline.
The shares fell 2.1% on the news.
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 is under pressure, as are margins and profits. A merger with Asda is the group's solution. It has several eye-catching features.
The combination should lead to more advantageous buying terms. Add in the potential for logistical savings, and Sainsbury reckons the combination can boost cash profits (measured by EBITDA) by £500m. That's on top of the £200m expected from business as usual this year.
The group has pledged to pass a good deal of those savings on to consumers though - more evidence the price wars aren't over.
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 debt to EBITDA ratio 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 obligations should help pay down the debt.
For all its attractions, the deal shouldn't be thought of as an unmissable 2 for 1 special offer.
Until recently operating profits were 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.
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 the sector's less concentrated these days.
Nonetheless, there's every chance approval would come with some painful conditions attached. The CMA's final decision is due in March.
For now, the shares offer a prospective yield of 4.2%.
Third quarter trading details
Grocery sales rose 0.4% in the period, led by online (+6%) and convenience (+ 3%). Sainsbury continues to invest in growing sectors of the market, including its 'free from' range, where sales rose 14%.
While Argos outperformed a weak and highly competitive market, group general merchandise sales fell 2.3%, and margins remain under pressure. The group says that's due to cautious customer spending and its decision to reduce promotional activity across Black Friday. Clothing sales dipped 0.2%.
23 Argos stores were opened in Sainsbury's supermarkets, bringing the total to 274.
Sainsbury's Bank continues to grow, with a 9% rise in customers, and a mortgage book that now exceeds £1.2bn.
The group says it remains on track to achieve £200m of cost savings this year.
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 disclosure for more information.