The Surprising Truth About Sainsbury

Published in Company Comment on 11 May 2011

We shop more there than ever, but profits are merely back to 2003 levels.

If you wanted a case study of how staggeringly competitive UK retailing is, then you could a lot worse than consider Sainsbury (LSE: SBRY).

And you don't even have to go all the way back to its downfall in the 1990s, when Tesco (LSE: TSCO) finally overtook its 150-year old rival to become the UK's biggest grocer. You just need to consider the reign of Sainsbury's CEO Justin King.

Long lives the King

King took up tenure as CEO in 2004, in the face of a shareholder revolt over the previous boss, pay and bonuses, and a catastrophic new distribution system. In October he unveiled a grand three-year plan entitled 'Making Sainsbury's Great Again'.

Seven years on, and Wednesday's full-year results for 2010 still highlights a list of bullet points marking progress along the 'Making Sainsbury's Great Again' trail.

Sales have soared over King's tenure, too, with turnover rising from £15.3 billion for 2003 to very nearly £23 billion in the 12 months to March 19 this year. Sainsbury now puts 21 million sales through its tills each week -- one million more than last year and an all-time high.

So is Sainsbury great again? Sure, unless you consider profits. Underlying profit before tax is up 9% year-on-year to £665 million for 2010. But that's £2 million short of the profits it racked up back in 2003!

Yielding income

On a statutory level, Sainsbury's profits for 2010 are almost 13% up to £827 million, which is a little better than the City expected.

The full-year dividend is higher, too, with the annual payout raised 6.3% to 15.1p. The dividend is covered 1.75 times by earnings per share, which were up almost 11% to 26.5p.

Those earnings put Sainsbury on a trailing P/E of 13.2, inching down to 13 for the year ahead on prospects of meager 3% growth. The picture is of a lot of fuss and bother, for very little reward for shareholders, other than that attractive 4.3% dividend yield.

Marginally worse

Harsh? Just compare Sainsbury's ability to generate profit from those 21 million weekly customers against Tesco's, as revealed in the latter's recent full-year results.

Tesco posted sales of £67.6 billion, and underlying profit before tax of £3.8 billion, for margins of 5.6%. The same calculation for Sainsbury's yields a margin of merely 2.9%.

Now, there are lots of ways in which to measure margins, and Sainsbury executives would surely point to differences in the capital structures of the two companies, their property portfolios, the way Tesco is really financing its expensive rapid overseas expansion, and so on.

But I don't think any tweaks would change the basic message. Market leader Tesco is a formidable profit machine, while Sainsbury, third-place after ASDA, is running to keep up.

Given this disparity, you might wonder why Sainsbury is on a forward P/E of 13, and Tesco on a lowly 11?

Me too. Perhaps the Sainsbury's premium is due to takeover speculation that previously sent its share price up to nearly £6 back in 2007. Valued at £6.7 billion, Sainsbury is a digestible morsel for any predator crazy enough to want to enter the tooth-and-claw fight for UK shoppers. £33 billion Tesco is not.

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Spaced out

None of this is to say that King and his team aren't working hard to get the results they are achieving.

Non-food growth is proceeding at a great clip (albeit it from a low base), expanding three times faster than more traditional grocery fare. Sainsbury's smaller convenience stores have achieved scale, too, and are now a £1 billion business in their own right.

Sainsbury also added 1.5 million square foot of store space this year, which puts it ahead of its target to expand by 15% over two years, although personally I'm unconvinced the UK needs more supermarkets.

On that note, it's worth mentioning that Sainsbury now puts the value of its property portfolio at £10.5 billion, which is £0.7 billion higher than last year and an attractive asset set against the company's £6.7 billion market capitalization.

Given that supermarkets need, well, supermarket stores, I'd see it more as downside protection to the share price (currently 335p) than as hidden value to be unlocked, though.

Buffeted shareholders

As a shopper, Sainsbury has improved out-of-sight since 2003. I well remember the empty shelves at my local Hammersmith branch. At times it was more like a scene from the former Soviet Union than a modern supermarket operating in the most innovative retail market in the world.

But for shareholders who've been buffeted by everything from a 40% cut in its dividend in 2004 to multiple takeover bids, it's been a more ambiguous journey.

Sainsbury is a simple and understandable business on one hand -- the sort of firm that Warren Buffett would look for. Yet Buffett is actually a major shareholder in Tesco, which says it all.

For defensive investors who don't mind holding two supermarkets and are mainly after income, Sainsbury is a perfectly reasonable company to own. You might be surprised with a fancily priced takeover someday, too.

But given the fearsome competitiveness in the UK, Sainsbury's lack of overseas expansion options, and the backdrop of a sustained squeeze on household budgets -- as well as my holding of Tesco shares -- I won't be rushing to buy its shares for any reason other than taking evasive action in some rockier stock market of tomorrow.

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> Owain owns shares in Tesco, as does The Motley Fool. Check out our Foolish disclosure policy.

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Comments

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F958B 11 May 2011 , 12:42pm

Sainsbury's persistently low margins has been a disappointment for a long time.
Sainsbury's persistently low profit margin is far behind Tesco or Morrison.
I suspect that Sainsbury could be rejuvenated and turned into a lean and competitive outfit with earnings per share enhanced by 30-50% without needing to increase sales, but I also suspect that the radical changes needed could only be done if Sainsbury were taken private or purchased by venture capital.
Sainsbury's significant assets have made them the subject of potential bidders for a few years now, but nothing has yet materialised.

At present, considering the fundamentals and possibilities for the future, I rate Sainsbury shares to be fairly valued, with Tesco and Morrison's fractionally undervalued.
There's not much to choose between the "big three" FTSE supermarket companies.

I have large holdings in MRW and TSCO, but no holding in SBRY.
As I am already grossly overweight MRW and TSCO, I have no plans to add SBRY.

MDW1954 11 May 2011 , 3:10pm

Well said, F958B.

MDW1954 (Fool writer Malcolm Wheatley)

eccyman 11 May 2011 , 6:10pm

On the upside - Surely it's far easier for Sainsburys to improve their margins from 3% to 6%, than it is for Tesco to go from 6% to 12%.

On the downside - Who on earth in Sainsbury's thought it a good idea not own their own stores? Not only do you pay perpetual rent, you've to ask landlords permission to sneeze.

F958B 11 May 2011 , 6:57pm

eccyman

Yes, I doubt that TSCO or MRW could ever raise margins above 6-6.5% (currently about 5-6%), so their only major chance for long-term profit growth is the building of more stores, moving into other parts of retail and perhaps a small contribution from increases in like-for-like sales.

I think that Sainsbury's problem is a company-culture issue, with the company rather stuck in the past and the staff culture resists evolution into a highly efficient modern business model. Big companies *can* adapt, but sometimes the managers just aren't strong enough to push through what is needed, so the company slowly fades away, which is evident in SBRY losing the number one spot to TSCO about a decade ago, with SBRY managing little in teh way of growth since.

That is why I suggested the "cure" for SBRY's low-ish margins would be a buyout followed by a ruthless shake-up, with no whining shareholders to complain about the short-term pain required for longer-term gain.
If SBRY could attain similar margins to TSCO or MRW, the shares would look very attractive sit on a lowly forward P/E of about 9, with potential to increase the dividend yield to 6.5%.

But SBRY have had long enough to raise their margins and results are still lacking, so I would buy them for what they are, rather than what they might become in the future.
Fairly priced at the current 350-360p.

abrahamisaacs 12 May 2011 , 1:15am

But Sainsbury is safe. Tesco is less so in my view because of its only semi-successful international expansion, its banking activities and departure of CEO Terry Leahy. Although international & banking makes Tesco look sexy I think I am less likely to lose my money in Sainsburys than in Tesco. Plus I find the quality of products at Sainsbury is noticeably better than the relatively poor quality at Tesco. You can test that for yourself pretty cheaply: buy a tin of Sainsbury's sardines and a tin of Tesco's sardines and you will see the horrible extent to which Tesco cut costs. Yes Tesco's margins are higher than Sainsburys, because Tesco sells rubbish in comparison.

eccyman 12 May 2011 , 8:57am

#abrahamisaacs

Good post, it's all too easy to get wrapped up in the financials. Going down to local stores is important research and yes I agree that Sainsbury's is a far better shopping experience than Tesco

jackdaww 12 May 2011 , 11:10am

tescos sardines seem fine to me - havnt tried sains.

tescos overseas seems to be doing very well.

the change of ceo may be an improvement .

i would agree tesco have plenty of room for improvement.

if - and its a big if - tesco can make a good fist of its financial services, and come out as reasonably honest and decent, they could capture a big slice of the market.

Luniversal 12 May 2011 , 12:45pm

When's the next time we get the oldest rumour in the Square Mile- the Arabs are after Sainsbury?

I shop at all major supermarket chains regularly. Thefe is no systematic difference in quality or inventory control and prices of major items are cartelised. Everyone in the business knows they are, but the government is too spineless to tackle the problem. Little intruders such Waitrose and Lidl barely ruffle the surface.

The sham war over itsy-bitsy gains and losses in market share conceals the fact that much of the everyday shopping pound in this country is controlled by a 'Treasure Island' quadropoly.

Freestyle1 08 Jan 2012 , 5:40pm

Hi
I have recently invested in shares for the first time after my dad died. I bought Sainsbury's and Morrison's as I like the shops. I read some of the expert investors comments about Tesco's and do not believe a word. Their reign is coming to an end, not only do the sardines taste better at Sainsbury's, I have to take abrahamisaacs word on that being a Tuna man myself, but their aggression will be their undoing, it's just not cricket and at a time when the environment and the community become the in phrases from grass roots to government level, I believe aggressive growth into local areas will backfire and several Tescos shops have already been attacked and campaigned against - very, very bad publicity. I also believe that good quality, good service and generally a nice place to shop will gradually win the day, and I personally hate shopping at Tesco. So if not Tesco - Sainsburys and Morrisons seemed the next stop, double the investment in Morrisons though.

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