2023-04-29 08:33:58 ET
Summary
- UK grocer J Sainsbury reported a so-so set of results for FY2022/23, with retail margins falling amid its ongoing battle to hold on to market share.
- These shares have underperformed since my first article on the stock, and with the earnings outlook looking stagnant, I expect that to continue.
- Without an uptick in growth prospects, investors should demand a lower earnings multiple here.
I wasn't all that bullish on UK grocer J Sainsbury (JSAIY)(JSNSF) when I first covered it back in 2021 . A fiercely competitive operating environment had led to material profit margin erosion over the years, and without much by way of organic sales growth the stock just seemed to lack any real drivers for outperformance absent a deep discount on its valuation. At a then P/E ratio of 13.5x, that wasn't really on offer here.
These shares have muddled along in that time, with the London-listed stock falling around 6% in price terms but gaining around the same back in cumulative dividend payments for a flat return overall. The US dollar-denominated ADSs have performed worse on account of GBP weakness, though irrespective of currency fluctuations the shares have underperformed the broader UK equity space in that time.
Financial results released in the meantime paint much the same picture as before. Margins remain subdued and under pressure, with cost cutting measures largely used to fund price cuts as the company seeks to defend market share against discounters Aldi and Lidl. With that leading to a flat earnings outlook and little scope for an upward rating on the stock's valuation multiple, I maintain my initial 'Hold' rating for now.
Retail Margins Slip
FY2022/23 results painted a familiar picture for Sainsbury's shareholders, with sales up but margins in the core retail business falling amid the company's ongoing battle to price competitively and hold on to market share.
J Sainsbury: Annual Retail Operating Margin
Data Source: J Sainsbury Annual Results Releases
Retail sales of £28.664B were up 2% year-on-year (+5% including fuel), with growth accelerating throughout the year as higher food prices offset a fall in volume. Unpacking that a little, grocery sales were up 3% year-on-year and 10.6% on a three-year basis (i.e. versus pre-COVID levels), which more than offset a fall in General Merchandise ("GM") sales, which were down 0.4% year-on-year and 4.9% on a three-year basis.
Retail underlying operating profit was down, falling 7% to £926m as the company invested the fruits of its cost savings initiatives into lower gross margins. Retail underlying operating margin was 2.99%, a fall of 41bps on FY2021/22 and 31bps on its immediate pre-COVID level.
Image Source: J Sainsbury plc FY2022/23 Results Presentation
Offsetting the above to a small extent were higher profits at Sainbury's Bank, with underlying operating profit there up by 20% YoY on the back of higher lending margins and balances, as well as higher fee income (e.g. the travel money business as international travel rebounded post-COVID).
Image Source: J Sainsbury plc FY2022/23 Results Presentation
All told, underlying diluted EPS fell around 7% YoY to 22.7 pence, albeit that remains around 15% higher than pre-COVID levels.
Some Reasons For Cheer
Despite lower profits there is some cause for optimism here. Firstly, there are some tentative signs that Sainsbury's market share in grocery is at least stabilizing, with its grocery volumes outperforming the broader market last year.
Image Source: J Sainsbury plc FY2022/23 Results Presentation
Overall grocery volume share has also remained relatively stable over the past few years in the 11.3% area, while its customer satisfaction ratings augur well on that front going forward.
Image Source: J Sainsbury plc FY2022/23 Results Presentation
Secondly, performance at general merchandiser Argos, which Sainsbury acquired in 2016, looked solid, with sales growth increasingly sequentially throughout the year. Argos GM sales fell 0.4% YoY for the year as a whole, though Q4 FY2022/23 sales were up 7.6% YoY. On a three-year basis, Argos GM sales were up 4.2% in Q4.
I had somewhat mixed feelings about Argos at the time of the deal, with the downside being that it introduced a cyclical retailing business into an otherwise defensive retailing business. Looking ahead, I do worry that it will prove a drag going forward given UK consumer finances are meaningfully deteriorating amid high inflation and higher interest rates.
Finally, the balance sheet continues to improve, with Sainsbury's non-lease net debt position shifting to a net cash one last year. Overall net debt was also lower.
Little Upside At Current Share Price
Alongside continual downward pressure on grocery margins, my main concern with Sainsbury is that the valuation just doesn't leave much room for upside. At 275 pence in London trading, the shares trade on a multiple of 12x FY2022/23 EPS. Given the company's chronically low organic growth outlook (with little scope for meaningful overall market and share growth) and single-digit return on capital employed, I don't see many catalysts that could drive an upward rating on that figure.
J Sainsbury: Annual Return On Capital Employed
Data Source: J Sainsbury Annual Results Releases
With that, analysts are currently forecasting flat-to-lower EPS out to FY2024/25. On a flat PE ratio that implies a mid-single-digit annualized total return at the high end inclusive of the cash dividend, which yields 4.75% at time of writing. Absent a material uptick in its growth prospects I would be looking for the shares to de-rate to a lower P/E ratio before upgrading the stock to a Buy rating. Hold.
For further details see:
J Sainsbury: Still Lacking Clear Drivers For Outperformance