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Sainsbury - profits down and dividend deferred

Sophie Lund-Yates, Equity Analyst | 30 April 2020 | A A A
Sainsbury - profits down and dividend deferred

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

Sell: 220.70 | Buy: 220.90 | Change -0.50 (-0.23%)
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Sainsbury's full year group sales fell 0.1% to £32.4bn, reflecting a 0.6% decline in like-for-like (LFL) sales and includes weak general merchandise trading. Underlying operating profit was down 3% at £986m.

The group's base case scenario regarding coronavirus assumes lockdowns will ease by the end of June, but the business will be disrupted until mid-September. In this case, Sainsbury expects underlying pre-tax profit for 2021 to be broadly in line with this year. That reflects £500m of extra costs associated with the outbreak, weaker fuel, general merchandise, and clothing sales and lower profits from the bank, being offset by higher grocery sales and savings from business rates relief.

Due to the uncertain nature of the length and impact of lockdowns however, decisions on dividend payments have been deferred until later in the year.

The shares fell 2.3% following the announcement.

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Our view

It's a mistake to assume coronavirus is an out-and-out tailwind for supermarkets. Feeding a panicked, locked-down nation comes with extraordinary costs and changes to spending habits.

The outbreak has temporarily pushed customers down grocery aisles, and away from things like clothing and general merchandise. In the fullness of time sales should even out again, but the current disruption is masking some irksome underlying trends.

Sainsbury is relying on discounted prices to help grocery sales tick upwards, but growth is hardly stellar. Relying on promotions isn't a good look for the long-term either. If volumes falter it's not pretty for margins, which are already a little thin. Cost savings were meant to help offset this, but the extraordinary extra costs associated with current disruption means savings plans are being put on hold.

We'd argue more needs to be done on Sainsbury's proposition too. Recent panic buying did see sales spike, but by less than half the rate seen at Tesco. The grocery sector is now more crowded than ever. Aldi and Lidl offer cheaper alternatives, then there are more upmarket offerings like Waitrose, M&S Food and Ocado. And with the latter two teaming up to boost M&S' online footprint, competition is at fever pitch.

That raises the question of how sales and profits are going to be boosted longer-term. Ideally sales from Argos will help offset the sluggish performance in groceries, but at the moment this isn't the case. Argos is more vulnerable to shifts in discretionary spending than food, making the prospect of a recession worrying.

A tough macroeconomic outlook is a problem for Sainsbury's bank too. Higher provisions for people who default on loan payments, lower commissions from travel money and ATMs, and higher costs means the division will be loss making this year. This isn't the end of the world, but it puts more pressure on the rest of the business to pick up the pace.

Credit where it's due, the clothing business had been making good headway, and when the dust settles we'd hope this trend can continue. We can't knock the work that's been done to reduce debt either, meaning the balance sheet is in reasonable health.

Overall Sainsbury remains an important part of the UKs food infrastructure, so a certain amount of revenue is guaranteed and makes it a more defensive option than some other retailers. However there is plenty of work still to be done before we turn more positive, and we wonder how badly the current disruption has delayed any progress.

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Full year results (figures are underlying)

In Retail, worse weather compared to last year, disappointing general merchandise trading contributed to a 0.4% decline in sales to £26.9bn. Excluding fuel LFLs were down 0.2%.Together with a higher marketing spend there was 0.15 percentage point decline in operating margin to 3.3%, and operating profit fell 4.4% to £938m.

Grocery sales rose 0.4% to £19.5bn, as a weaker first quarter was offset by a stronger second half. The uplift was driven by lower prices. Online sales grew by 7.6%, convenience stores by 1.3%, but supermarkets saw a slight decline.

General merchandise sales fell by 2.9%, but clothing did well, with sales up 1.2%, and Tu clothing online grew 47%.

On a net basis Sainsbury ended the year with the same number of supermarkets, and reduced the number of convenience stores by 14. As at 7 March 2020, Argos had 882 stores and 281 collection points.

There was a 5% rise in financial services revenue to £569m, and total income was 1% higher at £444m. The net interest margin (the difference between the interest income generated by banks and the amount of interest paid out) fell slightly to 3.4%.

Retail cash capital expenditure was £599m (2018: £508m), however the group received more income from its investments over the year, meaning retail cash flow was 34% higher at £611m. Net debt was £1.2bn, compared to £1.5bn.

Looking ahead Sainsbury said that performance for 2021 will depend on how long lockdowns last. The group expects: normal grocery conditions by the second half of the year, continued significant double digit percentage sales declines for General Merchandise for the remainder of the first half and double digit declines in clothing, although they're expected to get better towards the end of the year.

Bad debts will increase in the finance business, and the division is expected to make a loss next year.

In 2020/21, Sainsbury's expects a non-cash exceptional depreciation and amortisation charge of £1.2bn.

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