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J Sainsbury Plc Interim Update – 22 January 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 a 16.8% 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 Fair Trade 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.

UK Grocery Market Overview

The UK grocery market is subject to fierce competition and is currently dominated by the “Big Four” supermarket chains, Tesco, J Sainsbury, Asda, and WM Morrison. These firms occupy what is frequently referred to as the middle segment of the market, while continental discounters hold the lower tier and the home grown, more quality-focused Waitrose and Marks & Spencer cater for the more affluent customers at the higher end of the income spectrum.

Index FTSE 100 Ticker SBRY.L Latest Close 264.00
52 Week High 369.00 52 Week Low 221.10 P/E (F) 9.6
Dividend Yield % 6.4 Dividend Cover 1.89 CEO: Mike Coupe
CFO: John Rogers Price Target 260.00

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J Sainsbury Plc shares break back above 255.00 pence as stores outperform rivals

Following a torrid three months for UK grocery chains, a better than expected Christmas trading update from J Sainsbury proved to be the catalyst for a strong recovery in the shares, which have now risen comfortably back above the 250.00 pence mark.

In detail, management reaffirmed their earlier guidance that the group’s sales performance in the second half is likely to be in line with that of the first half, where the like for like decline was more moderate than with peers.

This means that the group is likely to have suffered a like for like sales decline of roughly 2.5% for the year, while on the balance sheet side, it made progress toward offsetting the impact of this through £140 million of efficiency savings. These savings come as part of a larger drive to cut operating costs by a sufficient enough level to deliver permanent annual savings of £150 -175 million which, over time, will help to support both earnings as well as investment into price competition at J Sainsbury.

In addition to financial positives, management also highlighted further strong volume growth in its Sainsbury’s Finest  as well as non food (clothes + houseware).

However, the group CEO also sounded a cautious tone in relation to earnings by telling investors that underlying EPS is likely to be moderately lower in H2 than in the first half. This is given the front ended impact of cost savings and a better performance from Sainsbury’s Bank during H1.

Despite the dovish tone surrounding full year numbers we still see scope for a best in class earnings performance from J Sainsbury. Our own projection for full year EPS suggests 26.1 pence for 2014, comprised of 14.5 pence in H1 and 11.6 pence in H2.

We note that we are slightly below consensus (26.6) in terms of earnings projections, although our own expectations still imply a strong performance from J Sainsbury relative to its peers.  

The shares have responded to the update, rising from 229.00 pence at the beginning of January, to 264.00 pence at the latest close. Therefore, we continue to view J Sainsbury as our preferred play in the supermarket space as opposed to the likes of Tesco and WM Morrison, where earnings for 2014 are likely to be at least 50% lower than in the previous year.

J Sainsbury Plc Share Price / 8 Hour Intervals

J SAINSBURY PLC JANUARY

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The road ahead for J Sainsbury Plc

Despite some positive signs, the road ahead remains cloudy for J Sainsbury. Most notably because the effects of a fightback from both Tesco and WM Morrison, as well as a further expansion by the discounters, is not yet known.

A key concern here is that the likelihood of a fire sale of assets by Tesco, and possibly WM Morrison, could spark a deeper price war in the industry. Should this happen, earnings expectations for Sainsbury could be revised lower, which would then weigh on the group’s share price over the near term.

However, and despite this; our overall outlook for the group remains unchanged as we continue to hold an optimistic view of J Sainsbury in the medium to longer term.

This is as the group maintains a clear and respectable brand identity as well as a customer base that has, on the whole, remained loyal. Furthermore, the group remained unscathed during the days of the horse meat scandal, while throughout the broad based supermarket downturn of Q3 and Q4, it has still managed to generate growth in some areas.

In addition, we are further attracted to the entrepreneurial flair that the group has demonstrated through its tie up with Danske Supermarked which is set to see NETTO’s return to the UK after a four year long retreat.

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Balance sheet, dividend and valuation update

In relation to the balance sheet, management guidance suggests that overall net debt is expected to be no more than £2.4 billion, while gearing remains at acceptable levels. On the downside, similar to the rest of the sector, balance sheet liquidity remains low at Sainsbury although the picture here improves if the Sainsbury’s Bank is separated from the grocery operation before carrying out the analysis.

In terms of the dividend, management clarified their payout policy at a the half year update. This is that dividend cover remains a priority and, in light of current earnings pressure, total shareholder returns are likely to be lower this year than in 2014 when the group distributed 17.3 pence per share. Despite this, the group held the interim dividend at 5.0 pence during 2014.

“We maintain our interim dividend at 5.0 pence per share for 2014/15 and will fix dividend cover at 2.0 times our underlying earnings for 2014/15 and over the next three years” – J Sainsbury Plc H1 Results 

From a valuation perspective J Sainsbury appears to be priced close to fair value at present. This is as the group currently trades upon a forward earnings multiple of 10.1 X our full year estimate for EPS and 8.1 X 2013 EPS.

This compares well with Sainsbury’s more troubled competitors, Tesco & WM Morrison, who trade on forward multiples of 23.15 X and 17.36 X 2014 consensus estimates respectively.

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The takeaway

In the supermarket space we continue to see J Sainsbury as offering the best value amongst the big four. This is because its loss of market share has been less severe in comparison with peers, it has already achieved meaningful cost savings and also benefits from having a clear and viable strategy for growth in place.

A further reason for this preference is that we believe the challenges J Sainsbury will face during the quarters ahead will require less extensive or complex solutions than for instance, Tesco or WM Morrison, where price cuts are yet to be accompanied by any form of cost savings, restructuring of store space and the overhaul of product ranges.

Therefore, we continue to hold a positive outlook for J Sainsbury shares, which we see averaging their current price over the foreseeable future. This is while reassert, and caution, that there remains considerable downside still to play out in the cases of both Tesco and WM Morrison.

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