Is J Sainsbury (SBRY) a stock to own? Let’s start with the place to which many investors’ eyes are first drawn: the company’s share price chart.
Rewind the clock to 1 July 2020, and the release of a first-quarter trading statement for the 16 weeks to 27 June. While lockdowns had served up a huge rise in grocery sales, they had also wiped out profits and led to the dividend’s suspension. While relief from business rates had softened the blow, that too would soon be gone. Two months later, the stock reached a nadir of £1.79.
Despite that decline – and a horrible nosedive in 2022 – the five-year total return of 86.8 per cent since that trading update is almost 20 percentage points up on the FTSE All-Share.
So far, so encouraging. But widen the focus to a decade, and the compound annual total return drops from 13.2 per cent to 5.6 per cent. That falls to 4.4 per cent over 20 years, more than half of which would have been swallowed up by inflation. So do recent gains simply reflect low expectations in a sector that has long struggled to achieve a sound balance between capacity and competitiveness?
The fact that Sainsbury’s shares have sometimes resembled a leveraged bet on gilts, and therefore sentiment towards the UK economy – as can be seen from the chart below – suggests markets might be viewing matters through an altogether different lens.
Perhaps recent trading can help us understand more. This financial year’s first-quarter update, which landed on Tuesday, revealed a 4.9 per cent rise in like-for-like retail sales, excluding fuel. Careful navigation of the latest price wars has resulted in the highest market share since 2016, cementing three consecutive years of market share growth. Customer satisfaction levels with Sainsbury’s value proposition are reportedly “the highest they have ever been”, while the Nectar app continues to boost loyalty and support profits.
And yet shares in the group fell 1.1 per cent on the day, despite a slight rise in analysts’ average target price to 301.5p, an up day for the FTSE All-Share and a 1.1 per cent bump for key competitor Tesco (TSCO).
What had the market seen beneath Sainsbury’s cheery, almost self-congratulatory tone?
Let’s start with the all-important sales figure. Impressive as a 5 per cent increase in grocery sales sounds, we know from the British Retail Consortium that annual food price inflation hit 2.8 per cent in May and 3.7 per cent in June. While this was partly due to lower harvest yields, hikes to the national living wage and employers’ national insurance contributions appear to have been the big drivers. Another tax on packaging is likely to maintain the upward pressure.
Then there is fuel, which saw total sales dip by 13.6 per cent to £1.1bn in the period. Although the business ordinarily treats its forecourts as a separate item – owing to the volatility of prices at the pump and relatively stable margins – the downward trend in sales suggests the return on this asset base is thinning. It’s unlikely to improve. But while the business has modelled for a further 25 per cent reduction in fuel demand by 2030 (in the event of rapid electric vehicle uptake) its latest annual report revealed that this had not yet reached a level that might prompt impairment considerations.
Above all, for all the positive noises – typified by chief executive Simon Roberts’ gratitude for “our brilliant colleagues, suppliers and farmers for their care and commitment as we work together to deliver for our customers and communities” – there was little for investors to hang their hats on.
Caveat-filled guidance for “retail underlying operating profit of around £1bn” and “retail free cash flow of more than £500mn” was left unchanged. Given how even limited top-line momentum can swell a low-margin business’s bottom line, this was arguably a disappointment.
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The quiet part out loud
For seasoned followers of the sector, this disconnect is par for the course. Any grocer that announced plans to boost margins would, in the words of one Sainsbury’s insider, “end up on the front page of the Daily Mail the following day”. When value for money is your competitive currency, stating your ambition for profit maximisation risks a reputational hit.
So when it set an ambition to deliver “profit leverage from sales growth” in February 2024, Sainsbury’s went about as far as it could to say the quiet part out loud. This followed the Competition and Markets Authority’s initial judgment that rising costs – rather than competition issues or price gouging – were responsible for post-pandemic food inflation in the sector, and a bit more assertiveness from Tesco.
So how does the company hope to achieve this? According to its annual report, the equation is as simple as “food volume growth + cost-to-sales reduction + measured investment in the customer proposition”.
But while Sainsbury’s has some levers to pull – including personalised savings, investments in technology and canny marketing – it remains buffeted by a relentlessly price-focused consumer and intense competition. This is despite a slight bias towards some of the wealthier and more heavily populated parts of England, which all else being equal might help its investment case.
We can see this by charting the changes in the UK grocery sector’s Herfindahl–Hirschman Index (HHI), a measure of market concentration that is calculated by adding the squared product of each player’s share. For instance, an industry dominated by four equally large players would score 2,500, while a complete monopoly would produce an HHI of 10,000.
After growing steadily through the 1990s and early 2000s, the sector’s HHI peaked at 1,760 in 2008, when the combined market share of Asda, Sainsbury’s, Tesco and Morrisons was at its height. Over the subsequent 12 years, concentration markedly declined as the legacy giants’ diminishing returns forced them into retreat, and the German discounters’ share swelled from 5 to 14 per cent.
A plateau in the sector’s HHI since the pandemic has disguised a couple of trends. While the two biggest players’ market share has climbed to decade highs, the big transfer has been to Aldi and Lidl from the private equity-backed (and wavering) Asda and Morrisons. Today, as the discounters reduce their growth rates, Sainsbury’s biggest opportunity may therefore lie in the frustrations of Asda and Morrisons customers.
Or is this reaching? When investors normally talk about ‘opportunity’, they tend to mean a pathway to higher profits. Even with recent tailwinds, Sainsbury’s has only managed to hit £1bn in statutory annual operating profits once, in the 12 months to 28 February 2020. Consensus estimates for the current financial year of 22.3p a share are barely higher than they were in July 2021, casting doubt over the ease with which operational gearing can kick in.
This is the mirage buried in Sainsbury’s investment case. While it is doing well with the things it can control – and always has dozens of highlights and business-enhancing initiatives to talk about – it is ultimately beholden to the things it can’t. Between its exposure to a wobbly UK economy, soaring levels of retail crime, political scrutiny and an ever-upward cost base, the medium-term profit outlook is likely to be a hostage to fortune.