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 J Sainsbury Plc Full Year Update – 07 May 2015

Company Overview

Founded in 1869, J Sainsbury Plc is a UK grocery retailer that operates more than 1,200 stores and employs 161,000 people in Britain. The group is divided between three divisions: Grocery Retailing (Sainsbury’s), Financial Services (Sainsbury’s Bank) and Property Investment (joint venture with British Land).

The group holds almost a 17% share of the UK grocery market and is often perceived by consumers to be an upmarket brand with a bias toward quality as opposed to value or price-driven retailing. The group also boasts of being the largest Fairtrade retailer in the world, the sixth largest retailer of children’s wear in the UK by volume, as well as the seventh largest purveyor of home ware and small ticket household goods.

Index FTSE 100 Ticker SBRY.L Latest Close 267.00
52 Week High 349.00 52 Week Low 221.10 P/E (F) 12.5
Dividend Yield % 5.0 Dividend Cover 2X CEO: Mike Coupe
CFO: John Rogers Previous Price Target 260.00 Current Price Target 299.00

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J Sainsbury shares recover lost ground throughout Q1

Since our last update J Sainsbury shares have managed to keep their heads above water by holding onto the gains made throughout early January. Key to this has been ongoing growth in like for like sales across most outlets, a strong performance from the group’s convenience stores and continued growth in its non food offerings of clothing and household goods.

In addition to this, the decline of the group’s market share has been less than than that seen across all of the other major grocers during the last 18 months, which has enabled Sainsbury to project itself as a more viable destination for investment than its listed counterparts.

Furthermore, in Sainsbury’s full year results update management announced that they would be paying a final dividend of 8.2 pence per share, which brings total dividends for the year to 13.2 pence. While this is lower than in the 2013 year it still provides investors with a yield of 5%, which is more than can be said for some of the group’s competitors.

Although WM Morrison paid a slightly higher dividend for 2014, its underlying business has been loss making for the last two years and even on a best case scenario basis, it is difficult to envisage the group being able to generate sufficient earnings to cover similar payouts over the coming 12 – 24 months.

As a result, we continue to rate J Sainsbury as best in class when it comes to the dividend outlook and future earnings prospects. Today we provide an overview of the group’s 2014 results, financial position and the current industry backdrop; before outlining why we have raised our price target for the shares.

J Sainsbury Plc Share Price / Daily Intervals

SAINSBURYEASTER

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Industry Review: Pain for the UK grocery sector as a whole may be beginning to subside

The most notable event for the industry as a whole during the first quarter of this year was a report released in February by retail analysts Kantar WorldPanel.

Here, the group detailed a best in class performance from Sainsbury in terms of market share retention and footfall, although it did also highlight that market share was still lower than in the same period last year. This is while Tesco is believed to have suffered the highest level of customer attrition during the period. 

In terms of prices, inflation in the grocery retailing sector was also reported to have fallen for 17 consecutive periods, with average store selling prices during the 12 weeks leading up to the report’s compilation some -1.2% lower than in the same period the year before.

However, despite what must seem like an ever present cloud of doom and gloom overhanging the sector, there may still be some hope for the big four in 2015. This is because the same Kantar Worldpanel report also highlighted that sales growth at the discounters was beginning to slow, with one analyst commenting that the sub sector will probably find it difficult to maintain their earlier rate of expansion throughout the 2015 year.

This could mark the beginning of a period of relative stabilisation for the UK grocery sector, although we will need to see conclusive evidence of a positive effect upon activity at Tesco in order for us to upgrade our view of the company.

In our view, the area of most significance for J Sainsbury going forward will be market share and any consequent growth in the volume of transactions which the customer base undertakes. This is because volumes will be key in a world where margins are expected to remain in the low single digits for quite some time to come.

Kantar WordlPanel Chart highlighting changes in market share within UK grocery sector

KANTAR2015

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J Sainsbury full year results overview

J Sainsbury said goodbye to what has been a terrible year for all of the large UK supermarkets on Wednesday when it released preliminary results for the period.  

The announcement saw management detail what was a remarkably strong performance when compared against some of the numbers to have been reported by competitors, with the decline in group sales confined to the low single digits and the decline in underlying profits capped below 20%. In this regard, we note that the fact that there was a decline at all reflects the extent to which the group has cut prices to maintain competitiveness during the period.

However, despite the many positives, in the face of diminishing margins at the industry level Sainsbury could not escape the need to revalue its property portfolio and to review its new store pipeline.

As a result, it is write downs relating to property and store leases (£628 million) that were the predominant drivers behind a total of £752 million in impairment charges for the year, which were in turn responsible for the group having to report its first annual loss for 10 years (-£166 million).  

Once all is said and done, Sainsbury shareholders were left in the red by £166 million which equates to a per share loss of 8.7 pence for the period. Although this means that the dividend was not covered at all for 2014, we are encouraged by the fact that if it hadn’t been for the one off charges, Sainsbury would have reported basic EPS of 26.4 pence.

This represents a much lesser decline than those we have seen elsewhere, with underlying profits at Tesco down by 75% and underlying profits at WM Morrison down by 50% for 2014 alone.

J Sainsbury Plc Income Statement for year ending 14 March 2015

SBRYINCOME

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Balance sheet

In relation to the balance sheet, total borrowings fell during the 2014 year at J Sainsbury albeit by a meagre £18 million. This leaves the debt/equity measure at 0.49 X and total gearing at 33%, both of which are well within the bounds of what can be considered as reasonable.

The above headline metrics also leave Sainsbury with the strongest balance sheet out of the big four grocers who are listed here in the UK, although we should caution that these figures only take account of interest bearing borrowings. They do not reflect the true level of indebtedness as like Tesco, J Sainsbury also has large unfunded pension liabilities.

Nevertheless, we continue to see the group as well funded and consequently, we offer no objections or cautionary statements in regards to its financial position.

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Cash flow

In regards to cash flow, Sainsbury currently consumes roughly 30% more cash than it is able to generate from operations. While much of the outgoing cash relates to the purchase of property, plant and equipment; if such a situation were allowed to continue then the group could find itself eventually being forced to resort to ever increasing levels of debt finance in order to fund itself.

Although we believe that the prospect of a cash crunch at Sainsbury is highly unlikely, we cannot say in this case that the group is ahead of the pack as WM Morrison actually leads the way in terms of its cash generation and cash management at present.

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Dividend

Sainsbury’s paid dividends totalling 13.2 pence for the 2014 year, which provides a yield of 5% at current prices, with cover of 2 X if we strip out the impact upon earnings of one off charges for the period.

We are encouraged by management’s pledge to maintain dividend cover at 2 X during the coming years as we feel that given the uncertain outlook for earnings across the sector, this is the best way for the board to avoid shareholder disappointment and a consequent revolt.

However, we do caution investors against excessive optimism as it is certainly possible that earnings could fall further during the year ahead and this would constrain the ability of management’s  to offer the same or a similar payout in May 2015.

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Valuation

From a valuation perspective, we believe that J Sainsbury is close to being fairly valued at present, although there remains some scope for further upside in 2015.

This is as the group currently trades on a multiple of 12.5 X consensus estimates for EPS in 2015, which is by far the lowest and most reasonable forward price to earnings valuation out of all of the big four grocers who are listed in the UK.

A brief look at consensus estimates and current prices across the remainder of the big four (UK listed) shows Tesco trading on a considerable 29.9X 2015 EPS and WM Morrison at 16.9X.

Using this style of analysis one could be forgiven for thinking that the market is pricing in a recovery throughout much of the sector and that J Sainsbury is either undervalued, or yet to experience its fair share of turmoil; hence the lower vote of investor confidence. However, we disagree with this view as our belief is that current consensus estimates are overly bearish, in that they all appear to suggest the same level of contraction in EPS that was seen in 2014 will be recurring in 2015.

We do not think that this will be the case as there are already signs that growth among the discounters is beginning to slow, while the haemorrhaging of market share by the big four has also begun to lose traction.

In addition to this, given that J Sainsbury and Tesco have both previously announced big write downs, we are also optimistic that impairment charges will have less of an impact on the bottom line for the year ahead.

If we are write on these points then higher levels of EPS should automatically lead to a certain amount of multiple compression across the sector, although we still view Tesco and WM Morrison as overvalued and overdue a re rating lower.

In the case of Sainsbury we think that upside surprise is equally likely when it comes to earnings for 2015, which should again lead to some form of valuation compression. Our base case assumption is for a lesser contraction in underlying earnings of 10% this year (23.0 pence EPS), which is significantly above the -19% consensus.

If we are right on this point then management would be able to support a broadly similar dividend payment for 2015 which would be a big plus for investors, one that could then support a sustainable advance by the shares back to the 300.00 pence level.

Our conclusion today in terms of the valuation is that relative to the sector, J Sainsbury remains the most attractive given its comparative stability in an environment where dividends are likely to be non-existent (Tesco), or just teetering on the verge of being cut or reduced significantly (WM Morrison).

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The Takeaway

Looking on the bright side for much of the industry, growth at the discounters is now beginning to slow according to recent reports by Kantar Worldpanel, although it still remains in the double digits. This could be an indication that the big four may be able to expect their respective market shares to stabilise over the next 12 -18 months or so.

At the company level, we continue to see J Sainsbury as the best in class, with a more favourable outlook for earnings and the dividend. This is while the group is further supported by a low valuation relative to the sector, which could reduce further if we are right in our expectations for earnings in 2015.

We go out on a limb today and project that the contraction in earnings for 2015 will be less than the consensus currently suggests, with our exact projection being for a decline of -10% VS the consensus of -19%.

We also use this assumption and the resultant implication for EPS (23.0 pence) at the close of 2015 to inform a change to our price target of 260.00 pence for J Sainsbury.

In short we revise our price target higher today from 260.00 pence to 299.00 pence per share, which corresponds to an earnings multiple of 13 X our 23.0 pence projection for EPS in 2015, while also marrying closely with the 38.2% retracement off from lows set within the November 2013 – December 2014 trend.

The next major scheduled event for J Sainsbury shareholders will be the release of the Q1 Trading Statement on 10 June 2015.

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IMPORTANT:
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