Interactive Investor

Sainsbury's shares at six-week high after profit upgrade

12th January 2022 08:20

Richard Hunter from interactive investor

Life isn't easy for the supermarket giant, but these third-quarter results are good enough to keep a rally following the Omicron crash intact. 

While there are some clear reasons for cheer within this third-quarter update, there are also some concerning developments at Sainsbury's (LSE:SBRY), and within General Merchandise in particular.

Against strong comparatives, limited supply and weak demand in some of its key categories, GM sales at both Argos and within the supermarket itself have fallen on both a one- and two- year basis. Sainsbury's has highlighted particular declines in technology, gaming and toy market sales, with the well reported disruption to supply chain blockages playing its part. 

More broadly, ongoing investment in the business, both in terms of price competitiveness and ramping up the online operation will also continue to pressure margins, and this is within an environment where the ferocity of competition shows no signs of wavering. The transformation of the Argos store estate is also a drain on resources, although the benefits should wash through in the longer term.

Despite these pressures, Sainsbury's has been making some promising progress at the headline level. Its focus on price and service resulted in a market share gain over the period, which implies some defence against the discounters who arguably provide the largest threat to the bread and butter business.

At the same time, the progress of the company’s online capability is clear to see, with online grocery sales for the 16 weeks to 8 January 2022 up by 92% as compared to the pre-pandemic period, demonstrating a shift in both consumer behaviour and Sainsbury’s ability to deliver. In recent weeks, it has fulfilled over 700,000 orders per week, and in the week leading up to Christmas, orders jumped by 41%.

Some of the decline has been self-inflicted, in that Sainsbury's has chosen its battles carefully, deciding in some categories to run fewer promotions in an effort to protect margins. At the same time, margins at Argos are now improving following operational cost reductions, even if the level of sales are under some pressure.

In all, Sainsbury's may be given the benefit of the doubt. Structural cost savings and better-than-expected grocery volumes have resulted in an upgrade to guidance for full-year pre-tax profit, to a figure of £720 million from the previously estimated £660 million. 

The profit upgrade vindicates what has been a relatively strong price performance, with the shares having risen by 15% over the last year, as compared to a hike of 11% for the wider FTSE100 index. Whether the improved outlook is enough to upgrade the market consensus of the shares, which currently stands at a "hold", remains to be seen.

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