Stockwatch: a springboard for this FTSE 100 share to rally
There was a negative reaction to recent results from this high-profile company, and analyst Edmond Jackson is surprised. He believes there’s reason to buy the shares here at a historic support level.
8th November 2024 13:07
by Edmond Jackson from interactive investor
For reasons I shall explain, I was a bit surprised to see Sainsbury (J) (LSE:SBRY) falling yesterday in response to interim results – initially down around 2% then closing 4% easier at 257p. This morning, the price has fallen again to 248p, where support has kicked in a number of times over the past few years.
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The prospective dividend yield is currently around 5.5% and September’s net tangible assets constitute 97% of market value, which intrinsically implies downside protection despite market price being in a firm downtrend from 300p since end-September.
In a five-year context, however, this merely continues a sideways-volatile trend since early 2023, with the price currently at that low – and possibly “buy” – point, after the 2020 to 2022 rollercoaster when supermarkets benefited from pub and restaurant closures during lockdowns:
Source: TradingView. Past performance is not a guide to future performance.
What has changed however, for taking one’s cue from the chart, is the Budget-hiking employer national insurance (NI) contributions to 15% of wages from the next tax year. The market is trying to price this in, notwithstanding guidance in yesterday’s interim results (to 14 September) for strong profit growth this financial year to end-February 2025.
Groceries are performing well, I believe because Sainsbury’s stores – at least the larger ones – offer the best all-round choice for variety, quality and keen pricing. Marketing-wise, they have cracked it, to become the UK leader in terms of overall offering. A stronger performance is also expected from Argos in the second half.
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One estimate, however, suggests the NI changes will cost Sainsbury’s £140 million next financial year; that’s in context of a recent consensus for net profit to re-rate from £137 million to £501 million in respect of February 2025 and £568 million in 2026. That would imply a downgrade heading towards 30% unless further actions are taken on costs – but perchance this is happening by way of a three-year £1 billion cost savings programme out to the 2026-27 financial year. Possibly some fine-tuning along the way will at least mitigate the extra NI cost.
M&S shares barely affected by Budget change
Marks & Spencer Group (LSE:MKS) shares have barely flinched. Indeed, they hit a seven-year high close to 400p – currently 390p – in response to strong interim results last Wednesday.
Its financial dynamics are currently stronger than Sainsbury’s, however the dividend yield is only around 1.7% and net tangible assets constitute 35% of market value.
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M&S’s forward price/earnings (PE) multiple is only slightly higher at 13.5x versus 11x for Sainsbury’s, although it constitutes a “turnaround to growth” situation with normalised earnings per share (EPS) growth over 20% expected in its current financial year to 31 March 2015, possibly below 10% next year as the NI burden weighs.
Consensus for Sainsbury’s has been a fall in EPS of over 20% this year, and possibly the rebound is limited to around 10% to February 2026.
Such a perspective risks short-termism, but fair credit to M&S, that it is achieving stronger performance by comparison. Versus Sainsbury’s, and in terms of share trend, it is a classic example of whether to back a momentum play versus a sideways-volatile trend starting to look looking attractive for yield:
Source: TradingView. Past performance is not a guide to future performance.
Also, M&S is relevant for showing the timescale over which shares may “mean-revert” to trade more appropriately relative to asset value, reflecting management’s overall success (or otherwise) with the business. I first made a “buy” case for M&S at 88p in May 2020 based on a 30% discount to net assets, with the clothing side struggling to progress from a reliance on essentials and formal wear. The net asset value (NAV) discount still offered a margin of safety and, in time, management has turned around the clothing business. But it’s been four years for a low against NAV to become an overt momentum share.
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If you include £811 million of intangible assets - to some extent fair, given Sainsbury’s has a good reputation - then NAV per share is around 280p per share. I would tend to regard this as limiting downside risk rather than any margin of safety as applied to M&S, implying upside as and when the business story improves. Sainsbury’s is already at or near “as good as it gets”, retailers need to keep making improvements just to stand still in a changing world; whereas M&S four years ago offered a chance for turnaround of clothing to re-rate value.
A contingent liability for employee pay
Sainsbury’s is not alone among retailers for being subject to current and ex-employee claims for equal pay, according to several Acts of Law. Just scroll down to note 16 in the interim accounts. There are around 17,000 such claims from some 11,900 claimants alleging their work within the stores was of equal value to those working in Sainsbury’s distribution centres, hence are seeking differential back pay.
The group believes further claims will be served but, given the outcome of two further litigation stages “over several more years”, the uncertainty of outcome means nothing is as yet provided for in the accounts.
You take your view therefore about whether this rules out affected retail shares, or from a yield perspective is actually useful because the market will price for a yield high enough to attract investors, notwithstanding the risk.
Interim results affirm strength for dividend income
Underlying group operating profit is up 4.7% on sales up 3.1%, reflecting improved cost control and operational gearing.
Management thus proclaims a strong start to its “next level” strategy set out last February: leveraging profit from food volume growth ahead of the market. Customer satisfaction and employee engagement rates are rising, and more customers are choosing Sainsbury’s for their main shop, driving the biggest market share gains in the industry. Basket size growth is significantly ahead of competitors.
The high cost nowadays of “treat” dining out appears to be supporting Sainsbury’s premium Taste the Difference products which now appear in one in three baskets.
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Altogether it has meant six consecutive quarters of volume growth; though obviously, any business needs to achieve such simply to stand still if there is any inflation in the wider economy. Ongoing food price inflation will also have contributed to revenue growth.
Groceries thus rose 5.0%, with group revenue checked by general merchandise and clothing easing 1.5%, and Argos down 5.0% also fuel sales down 4.4%.
Financial services did very well up 38%, albeit from a small base, to £18 million. Restructuring this division was chiefly responsible for a £176 million non-underlying items cost, responsible for a 51% drop in statutory after-tax profit to £76 million.
Retail free cash flow was £425 million and is on track to deliver at least £500 million in the current financial year, equating to at least 21p per share. The table shows this being in a low median position of the 17.0p to 79.1p a share range of the last five years.
J Sainsbury - financial summary
Year to end-Feb
| 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | |
| Turnover (£ million) | 29,007 | 28,993 | 29,048 | 29,895 | 31,491 | 32,721 |
| Operating margin (%) | 2.0 | 2.3 | 0.6 | 3.9 | 1.9 | 1.8 |
| Operating profit (£m) | 592 | 679 | 165 | 1,161 | 609 | 571 |
| Net profit (£m) | 186 | 152 | -201 | 677 | 207 | 137 |
| EPS - reported (p) | 7.5 | 5.8 | -9.4 | 28.8 | 8.8 | 5.7 |
| EPS - normalised (p) | 28.9 | 21.2 | 18.3 | 22.6 | 42.5 | 27.5 |
| Operating cashflow/share (p) | 42.3 | 55.5 | 106 | 42.9 | 92.9 | 82.1 |
| Capital expenditure/share (p) | 23.9 | 25.9 | 26.9 | 29.5 | 31.4 | 65.1 |
| Free cashflow/share (p) | 18.4 | 29.7 | 79.1 | 13.4 | 61.5 | 17.0 |
| Dividends per share (p) | 11.0 | 3.3 | 10.6 | 13.1 | 13.1 | 13.1 |
| Covered by earnings (x) | 0.7 | 1.8 | -0.9 | 2.2 | 0.7 | 0.4 |
| Return on total capital (%) | 3.7 | 4.3 | 1.2 | 6.8 | 4.2 | 4.2 |
| Cash (£m) | 1,332 | 1,076 | 1,665 | 1,021 | 1,813 | 2,004 |
| Net debt (£m) | 6,434 | 5,994 | 5,273 | 6,361 | 5,332 | 4,545 |
| Net assets (£m) | 7,782 | 7,791 | 6,701 | 8,423 | 7,253 | 6,868 |
| Net assets per share (p) | 353 | 351 | 300 | 361 | 308 | 290 |
Source: company accounts.
Even so, the interim cash flow statement cites net cash generated from operations down 47% to £592 million. This did however amply cover around £400 million investment and £217 million in dividends, although cash reserves - £1.6 billion as of 14 September - were applied for share buybacks.
The table shows Sainsbury’s capital expenditure needs can be significant and variable, affecting free cash flow – the chief factor for dividends. Balance sheet cash should buttress payouts, however, against such variability and possibly also the long-term pay liabilities.
Respecting Sainsbury’s marketing position, financial performance and strengths, I therefore believe it is entering a “buy” range intrinsically. Not as attractive (with hindsight) as Marks & Spencer was at around 100p, but where income funds are likely to start feeding on the shares.
The chart says wait, and management affirming what NI liability could also weigh. But the yield and asset backing should start to lend support.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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