Sainsbury's and the share price catalysts

by from interactive investor |

The grocery trade remains tough, but a canny acquisition and planned mega-merger are major catalysts for the share price, writes Lee Wild, head of equity strategy at interactive investor. 

Sainsbury's has its hands full integrating Argos and planning its next adventure with Asda, but both are going to plan and the underlying business has momentum.

Total sales grew by 3.5% in the 28 weeks ended 22 September to £16.88 billion and retail sales by 1.2%, or 0.6% on a like-for-like basis excluding fuel. Profit before tax and any nasties was up 20% to £302 million, but the cost of restructuring, integrating Argos and £17 million spent kicking off the planned merger with Asda caused a 40% drop in statutory profit to £132 million.

A 1.5% increase in sales at Argos and the other general merchandise businesses was better than the wider market, but lower margin consumer technology products crimped returns.

The idea of opening Argos stores in supermarkets is working well, and Sainsbury's has hit its £160 million savings target nine months early. Elsewhere, the business should hit its own £200 million savings target by year-end and "at least" £500 million in three years.

Source: TradingView (*)     Past performance is not a guide to future performance

That there's not much to say on the Asda deal is unsurprising given the ongoing regulatory review.

There are so-called problem stores that will have to go to make it happen, but the merged business could afford to offload hundreds of stores, and is certainly not a blocker. Unfortunately, regulators are unlikely to give the go-ahead until the spring, delaying completion until months after.

This is a real game-changer for the industry, and a huge test for chief executive Mike Coupe and Co. But the Sainsbury's team has made a success of the Argos acquisition and stand a good chance of pulling off this much larger deal, too. Coupe will be judged on the outcome.

And the market is optimistic. Sainsbury's shares are not far off a 16-month high and up over 40% since March, thanks in large part to April's Asda announcement. 

Margins have suffered at the hands of the German discounters and, although the worst is over, business remains tough. Tesco was punished last month for missing half-year expectations, and Morrisons suffered a similar fate this week following a third-quarter slowdown.

Sainsbury's admits that consumer uncertainty will make the crucial second-half difficult, and that clothing is fiercely competitive. However, it's confidence in meeting forecasts for underlying full-year profit of £634 million is reassuring.

We said back in April:

"Given the lengthy review process and that the deal will not complete until the second half of 2019, Sainsbury's shares may struggle to do much better than today's peak at 327p. Hold."

Well, they made it to 341p in August before drifting back below 300p briefly last month. Today's best was a fraction under 325p. And the thinking remains unchanged. The Sainsbury's-Asda deal underpins the current share price, but it will be strong Christmas trading and a green light from the regulator that provide the real catalyst for a break higher.

*Horizontal lines on charts represent levels of previous technical support and resistance.

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