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Sainsbury - outlook unchanged, strong first quarter sales

Sophie Lund-Yates, Equity Analyst | 1 July 2020 | A A A
Sainsbury - outlook unchanged, strong first quarter sales

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

Sell: 204.20 | Buy: 204.40 | Change 1.50 (0.74%)
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Total retail sales excluding fuel rose 8.5% in the first quarter. That reflects improvements in Grocery and General Merchandise sales, while clothing saw declines. Overall like-for-like (LFL) sales were up 8.2%.

COVID-19 is expected to affect full year profits by over £500m, but this will be mostly offset by business rate relief and higher sales. While uncertainty remains, Sainsbury continues to think underlying pre-tax profit will be broadly the same as last year.

The shares rose 1.5% 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.

That means despite increased sales full year profits are expected to be flat. It's a similar story at some of the other big supermarkets too, and instead it's important to look at the bigger underlying picture.

We can't deny some headway has been made, particularly in the General Merchandise space. The Argos integration has provided a boost during recent months as the nation got busy working from home and baking up a storm. How long this momentum can continue will depend on how the UK's economic landscape shapes up. Argos is more vulnerable to shifts in discretionary spending than food, making the prospect of a recession worrying.

Investors also need to remember groceries are Sainsbury's bread and butter. And the group's been relying on discounted prices to help boost grocery sales. A huge increase in online capacity has also helped, but both of these developments are preying on 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. 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. 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.

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 work still to be done, and we'd like to see exactly how the group plans to harness the recent run of encouraging momentum before turning more positive.

Sainsbury key facts

  • Current 12m forward P/E ratio: 11
  • 10 year average 12m forward P/E ratio: 11.7
  • Prospective yield: 5.0%

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Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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First quarter trading details

Grocery sales rose 10.5%, helped by an 87% rise in online sales. The group said around half of all new online customers hadn't shopped at Sainsbury before. Click and Collect orders were also up 13-fold in the period. In order to remain competitive Sainsbury has lowered the prices of a number of its key products. Growth elsewhere offset a 5% decline in convenience store sales, which have been impacted by low city centre footfall during lockdowns.

Clothing sales fell 26.7% for the quarter as a whole, but are recovering faster than expected. For the nine weeks to 27 June sales were down 10%. Tu online grew 87%, and the group has less excess stock than anticipated.

A 10.7% rise in Argos sales masked a 9.3% fall of in-store General Merchandise (GM) sales, meaning overall GM sales were up 7.2%. The warm weather and demand for home office and entertainment equipment helped drive the increase. 30.4% of standalone Argos stores are now open, with another 100 opening in July.

The Financial Services Division had £335m of surplus capital, up from £320m at the end of the last financial year. Cost savings and lower lending means the bank has £665m additional liquidity above the regulatory minimum. Lower demand for credit fed into an 8% reduction in unsecured debts. Lower credit card spending is starting to improve.

The group said its cash position remains strong, and it has chosen to fully repay the £500m it borrowed earlier in the year.

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