Time to go shopping for Sainsbury’s?

Sainsbury at 253p after the interim results. The traditional quoted food retail sector is still undergoing a big change on an undetermined time scale. On that basis, Sainsbury shares may not look an obvious buy. However, I argue that the shares are attractive when the financial fundamentals are recognised.  The shares, after the results of the first half of the current year, are priced at 253p and look pretty bombed out on those fundamentals.

Our home grown food retailers (who of course sell more than food) have been in the grip of an insurmountable problem: losing market share to outside competitors who have been increasing their market share.

Nothing can be more debilitating for a big business than the loss of scale and economic and financial benefits that come with scale of operations, whilst the competitive interlopers (in this case Lidl and Aldi, the Hengist and Horsa of UK retailing) are increasing and improving theirs. That is a bit like their fighting with one arm tied behind their back. The big question is how long it will take before the now more competitive sector settles down into a new equilibrium. No one knows and it is difficult to guess. Moreover, there are other threats to the current sector players – including the invaders. As our legacy retailers of staple products spot ‘on line’ shopping as a lower cost opportunity, internet operators like Amazon spot ‘on line’ sales of food stuff as a new market opportunity. We are clearly only part way through some pretty momentous changes in this sector; none of which are susceptible to clear visibility and easy prediction and certainly not credible forecasting.

However, as always, there is the usual solution of some future consolidation amongst the retreating traditional players like Sainsbury, Tesco, Morrison and Waitrose etc. I suspect that will become a genuine prospect in due course, particularly if Amazon come into the food retailing business – taking even more British Exchequer tax revenue to other taxation jurisdictions no doubt.

So, is there a case for buying UK food retailers and Sainsbury in particular? The elementary factors guiding us in answering such a question, include the following: that all companies in their activities are subject to degrees of uncertainty; share prices over time move to discount evolving news, facts and prospects; long term investors with wealth to preserve and hopefully grow, need a spread of investments and risk. That includes food retail shares of course.

Coming to Sainsbury specifically, the best argument for investing money in it in comparison with other retail shares is that the share price is now discounting the difficulties. The share price last seen was 253p after the last interim results. About two years ago, the share price was over 400p.

What does an investor now get for his or her money? First, a lot of sales revenue; on the basis of last year’s sales annual revenue at £23.5 billion on an equity capitalisation of £4.8 billion; put another way a share price of 253p buying historic sales revenue of an estimated 1,237p per share. Second, a very low price to book valuation. In fact the share price last seen stands at a 13% discount to balance sheet net assets in March. The market capitalisation of Sainsbury equity, currently standing at a value of £4.8 billion, commands an enterprise value which is three and a half times larger. In the balance sheet of 14th March last, total assets were stated as £16.5 billion. Also note that last year’s EBITD (basically profits before interest, taxation and depreciation are charged) amounted to £770 million putting Sainsbury shares on an EBITDA ratio of only 6.2 times on the basis of last year’s figures. Despite the gearing, interest costs were reportedly covered 6 times on an annual basis and 7.4 times on an interim basis. The shares price also stands at only 3.7 times last year’s annual cash and near cash held. Such valuations are strikingly low.

Turning to the latest interim results, the disappointing news include the facts that the interim dividend was cut 20%; that there was a loss of market share and thinner margins; that sales fell 2%; and that underlying profits fell by 18%.

The company is responding, we are told, by improving its own branded ‘taste the difference’ products, which, against the 2% fall in sales, actually grew by a reported 2% in volume terms.

However, the incoming new CEO Mike Coupe talks of cutting costs according to a programme that seems ahead of schedule. The company is also increasing its convenience stores (very much the fashion in the sector) where sales have risen by a reported 11%, on the back of a one fifth increase in the number of such stores.  Moreover, the retailer is developing its new Tu clothing offer –  sales up 10% over the first half –  as well as building its Sainsbury banking operation which is for the moment absorbing transformation cost. At a given point the bank should obviously be making a contribution to net profits.

The market is estimating a 17% fall in earnings this year to earnings per share about 22p, putting the shares on a forward estimated price to earnings ratio of just over 11 times. The consensus estimate, at this juncture, is for a further 2% decline in earnings the year after that. Interestingly, it forecasts top line sales revenue for this year as being static at £23.75 billion and pretty close to that again in the following year at an estimated sales revenue figure of £23.52 million. In essence then, the market seems to be calculating that Sainsbury will hold its sales, with a well understood fall in earnings this year but holding on to most of those earnings the following year.

The market consensus also estimates that the annual dividend will be reduced twenty per cent in line with the cut in the interim dividend. At the 10.5p dividend payout estimated for this year and next year the estimated annual dividend yield for this year and next is 4.4% p.a.

As I always say on such occasions, I am no more gifted in seeing the future than the rest of humanity. However, as a compensation for that lack of prophetic vision, I can identify value in the here and now. Sainsbury at this level shows quite a lot of what we call fundamental value, as indicated above. With the share price at a discount to balance sheet net assets, investors now are arguably being asked to pay nothing for earnings.

It will be interesting to see whether at this stage and at these levels of valuation, the bears will be tempted to fold up their short positions together with their tents. Sainsbury is reported to have been one of the most shorted shares in the market. Technically, the shares have been moving sideways for over a year in a trading range of roughly between 220p and 290p. Arguably, the share price looks as though it might have broken out of the earlier downtrend that took it into that range. Have a look and see if that is your interpretation.