Interactive Investor

Sainsbury's rockets after shock Asda deal

30th April 2018 13:53

Lee Wild from interactive investor

Mike Coupe had big boots to fill when he took over from Sainsbury's hero Justin King nearly four years ago, but the supermarket's chief grocer has already established a significant legacy and reputation for bold M&A.

Less than two years after completing the exhausting acquisition of Argos owner Home Retail, Coupe and his team, backed by 22% shareholders Qatar Holdings, have agreed a blockbuster £7.3 billion deal to combine Sainsbury's with Walmart-owned low-cost peer Asda.

In the supermarket industry scale is everything, and the new company will generate annual revenue of around £51 billion. It's why, even after slashing prices on popular lines by 10%, Sainsbury's expects to make savings of "at least" £500 million a year, mostly buying on better terms (£350 million) and housing Argos counters in Asda stores (£75 million).

Source: interactive investor           Past performance is not a guide to future performance

Coupe will have to spend money, of course, mainly £600 million on migrating IT systems, plus £150 million elsewhere. But that's of little concern to the investment community. Sainsbury's shares traded as much as 21% higher Monday at prices not seen since the early days of Coupe's reign.

It's unclear how much of Monday's rally is down to short-sellers buying back shares - so-called short covering - but analysts at UBS think the deal could be worth an extra 27.5% of earnings per share by 2022. If Asda maintains its current margin of 3.6%, that figure could reach 39%. In addition, every £100 million of extra savings on top of the predicted £500 million is worth 720 basis points.

It is not hyperbole, then, when former Asda man Coupe calls this a "transformational" deal. Shoppers get lower prices and more choice, while shareholders get a far more efficient business serving different demographics, and with firepower to take on the discounters.

The Sainsbury's/Asda combination faces regulatory scrutiny, yes, but there's a very good chance it will win approval from the Competition Markets Authority (CMA) - likely with some forced store disposals on the way - leapfrogging Tesco as the UK's biggest supermarket operation.

This is a real game-changer for the industry, and a huge test for Coupe and Co. But the Sainsbury's team appears to have 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.

That said, 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

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