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Morningstar | J Sainsbury Reports In-Line Interim Results; Argos Synergies Ahead of Schedule

J Sainsbury reported interim results for the 28 weeks to Sept. 22, with group like-for-like sales excluding fuel up 0.6%, in line with our expectations. Retail underlying operating profit increased 23.2% principally driven by cost savings and synergies, which were delivered nine months ahead of the original schedule. Management reaffirmed full-year guidance (GBP 200 million cost savings and GBP 100 million net debt reduction) and said the company is on track to deliver the current market consensus of GBP 634 million in profits (GBP 630 million in our model). After this mostly in-line print, we maintain our GBX 360 fair value estimate and no-moat rating.

The company didn't provide any meaningful update on the proposed merger with Asda and ongoing Competition and Markets Authority investigation, other than that it expects preliminary findings in January.

We note that although the grocer delivered the targeted Argos EBITDA synergies (GBP 160 million) since the half year faster than previously announced, there was no further guidance on synergies. Cost savings achieved for the half were GBP 121 million, with the rest (GBP 79 million) of the savings to be realized in the second half of the year.

Grocery sales advanced 2% in the second quarter (versus 0.5% in the first quarter), supported by the company's price investments in the first quarter, with healthy growth in online and convenience (6.9% and 4.3%, respectively). Still, we find the implied negative volume growth (less than 1%, according to management) disappointing, given the grocer's sizeable price investments in the first quarter. We will be closely monitoring volume growth numbers in the next quarter (and expect a noticeable improvement in grocery volume), since according to management there is typically a three- to six-month lag to customer response.

In other categories, clothing underperformed with sales declining 3.4% (versus 0.8% in the first quarter). General merchandise was up 1.5% with margins pressured on the back of higher sales from low margin electricals.

Excluding the potential benefits that will flow from the Asda acquisition (assuming a favorable decision by CMA), we think Sainsbury continues to be less well prepared to face the fierce competitive environment in the U.K. grocery market nowadays, and our stand-alone Sainsbury thesis remains intact: first on the need to invest more heavily back into the business to improve its pricing position relative to its big four peers, and second on the Argos deal, which we believe will not benefit the supermarket’s core grocery offering in terms of traffic and volume. Rather, it will add to its top- and bottom-line cyclicality in a soon-to-be post-Brexit world. On the flip side, we expect Argos, which garners over half of its sales online, to continue to benefit from this acquisition, chiefly because of higher footfall in Argos concessions than in Sainsbury’s supermarkets and better convenience through an expanded click-and-collect network.

Argos synergies (GBP 160 million) and cost savings (GBP 200 million in fiscal 2019 and GBP 300 million thereafter by fiscal 2021) should support profitability shorter term, but we think that longer term, J Sainsbury would need the Asda deal (better utilization of Argos, higher capacity to invest in prices, better platform to grow online, general merchandise, and clothing) to address its structural issues.