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

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Sainsbury’s like-for-like sales rose 3.4% in third quarter, excluding fuel. Growth was driven by a 5.4% uplift in Grocery sales as the group gained market share. Its premium Taste the Difference range grew at a faster pace of 15%.

Sales at Argos missed market expectations, falling by 1.0% as higher volumes were more than offset by lower average prices as consumers steered clear of big-ticket items. General merchandise and clothing sales at Sainsbury’s also missed forecasts, slipping 1.1% lower.

Full-year retail underlying operating profit guidance has been maintained at more than £1.0bn. Free cash flow guidance has been upgraded to more than £550mn (previously: more than £500mn).

The shares fell 4.1% in early trading.

Our view

Sainsbury’s grocery sales continued to impress in the third quarter, with growth landing ahead of market expectations. But non-grocery sales were a bigger drag on performance than markets were expecting, causing the shares to give up some recent gains on the day.

Sainsbury's groceries continue to gain market share, thanks to its herculean effort to improve products, value perception and innovation more generally. Things like the ALDI price match and Nectar prices are helping on this front too. They’ve been expanded across more products than ever before and are doing a great job at keeping customers loyal.

With operations focused on this side of the Atlantic, President Trump’s fluctuating trade policies pose little threat to disrupt operations directly. But Sainsbury’s is more exposed to general merchandise than its peers through its ownership of Argos, an area where sales have been weak in recent years. We’re starting to see the benefits of these soft comparable periods and improving profitability, but the space is likely to remain challenging for some time.

The top-line growth and efficiency improvements have been enough to offset rising national insurance and minimum wage costs, keeping profits moving in the right direction. With an all-out price war failing to materialise so far, and impressive grocery momentum over the festive season, full-year profit guidance looks well within reach.

The balance sheet was in good shape last we heard, with the ratio of net debt to cash profit (EBITDA) sitting towards the lower end of its target range. The sale of its banking operations should help sharpen management’s focus on the retail business, and has freed up £400mn to be returned to shareholders through special dividends and share buybacks over the next 18 months. With improving free cash flows, there’s plenty of weight behind the group’s prospective 5.0% dividend yield. But remember, no shareholder returns are guaranteed.

Sainsbury’s deserves credit for its steady strides forward in recent times. That’s been reflected by its valuation climbing above its long-term average, which now sits more in line with peers. The income opportunity looks appealing, and there’s scope to beat profit expectations in our view, if it keeps a tight grip on costs. But we prefer other names in the sector given the tough competition and challenges at Argos.

Environmental, social and governance (ESG) risk

The retail industry is low/medium in terms of ESG risk but varies by subsector. Online retailers are the most exposed, as are companies based in the Asia-Pacific region. The growing demand for transparency and accountability means human rights and environmental risks within supply chains have become a key risk driver. The quality and safety of products as well as their impact on society and the environment are also important considerations.

According to Sustainalytics, Sainsbury’s management of ESG risks is strong.

An area of strength is the fact that the group’s executive pay is explicitly linked to ESG performance targets. However, within that, the group’s ESG disclosures aren’t in accordance with leading reporting standards, in particular the environmental policy is weak. This is significant given the group’s extensive packaging and freight usage. The group’s large scale puts it at increased risk of scrutiny when it comes to product reputation, and is something to monitor as customer appetites lean more towards sustainable options.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by LSEG. 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.

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