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Sainsbury - restructuring costs swings profit to loss

Sophie Lund-Yates, Equity Analyst | 5 November 2020 | A A A
Sainsbury - restructuring costs swings profit to loss

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

Sell: 283.70 | Buy: 283.80 | Change 0.40 (0.14%)
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Group sales, excluding fuel, rose 7.1% to £14.9bn at the half year. That reflects increases in Grocery and General Merchandise, which offset declines in Clothing. Underlying pre-tax profit rose 26% to £301m.

However, Sainsbury has decided to accelerate the integration of its supermarkets and Argos stores and will close around 420 standalone Argos shops. It's also restructuring the store estate and supply chains, and has recognised a number of impairment charges relating to coronavirus. Including these extra costs, it generated a pre-tax loss of £137m.

The Board has chosen to pay a special dividend of 7.3p instead of a final dividend for the 2019/20 financial year.

The shares fell 2.4% following the announcement.

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Our view

It's a mistake to assume coronavirus is an out-and-out tailwind for supermarkets. Consumer demand, workforce costs and logistics have all changed - potentially for the long-term.

That's resulted in some hefty costs, which are holding back profits. That's a common problem for all supermarkets, but there are some Sainsbury specific headwinds too.

The current crisis has resulted in an expedited reshuffling of the Argos store closure and integration programme. While that makes sense on paper, the costs involved are huge and general merchandise is more exposed to shifts in discretionary spending. When the economic outlook is gloomy, electrical and household items find themselves rubbed off shopping lists. Together those issues mean execution risk is high and the near-term outlook for revenue is shaky.

However, groceries remain Sainsbury's bread and butter. And the group's been relying on discounted prices to help boost sales there. A huge increase in online capacity has helped, but the extra infrastructure comes with extra costs, so both of these developments are preying on margins, which were already a little thin. This trend could be set to get worse as the digital strategy accelerates.

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. This perhaps explains why Sainsbury failed to take more of peak lockdown trading. To its credit, it plans to shake up the supermarkets and improve its offering. But so far it's a long, relatively sensible, to-do list, rather than tangible progress.

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 successfully the group turns sound plans into profitable action before turning more positive.

Sainsbury key facts

  • Price/Earnings ratio: 10.8
  • 10 year average Price/Earnings ratio: 11.6
  • Prospective dividend yield (next 12 months): 5.3%

All ratios are sourced from Refinitiv. 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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Restructuring details and half year results (figures are underlying)

The restructuring efforts will involve opening 150 Argos stores in supermarkets, and 150-200 further collection points. The group is also creating a new integrated supply chain and logistics model across both Argos and Sainsbury's. As well as this, 15 - 20 supermarkets and 50 - 60 convenience stores will close, which is a higher number than previously announced.

The group has also permanently closed its meat, fish and deli counters as it looks to free up space for other products, and "reduce complexity" in its stores.

Around 3,500 roles could be cut, but Sainsbury expects to increase headcount by 6,000 by the end of the year.

The group concluded "the combination of COVID-19 and the accelerated integration programme is an impairment indicator", resulting in non-cash impairment charges of £214m. These are split fairly equally between the retail business and Sainsbury's Bank.

One off costs from these changes will be £900m - £1bn in the period to March 2024, with total non-underlying costs of about £625m to take effect this financial year.

Total Grocery sales rose 8.2% to £11.2bn, with online sales rising 102.2% and Convenience store sales falling 8%. General Merchandise sales rose 7.4% to £3.2bn, while Clothing fell 18.3% to £0.4bn. On a like-for-like basis (excluding fuel), total retail sales rose 6.9%. The government's Business Rate Relief offset higher costs, so on an underlying basis, retail pre-tax profits came in at £356m.

Online grocery capacity has more than doubled since March, and digital grocery sales now make up around 17% of total grocery sales.

Sainsbury's opened five new Convenience stores and closed two, Argos opened four new stores in Sainsbury's and 14 standalone shops closed. Habitat had 16 stores, of which 11 are in Sainsbury's.

There was a 24% fall in financial services revenue to £219m, and total income was 27% lower at £165m, reflecting lower interest income. Operating income fell from £20m last year to a £55m loss. The declines are a result of lower credit activity, and less demand for travel money and ATMs.

The net interest margin (the difference between the interest income generated by banks and the amount of interest paid out) fell to 3.1% from 3.5%. Expectations of increased unemployment means bad debt expenses as a percentage of lending rose 1.4% to 2.7%.

The group generated free cash flow of £1.3bn, up from £811m last year. Group net debt was £4.9bn as at 19 September.

Stronger than expected sales means full year pre-tax profit is expected to be at least 5% higher than last year.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.