A 20% Downside For J Sainsbury plc

Sainsbury’s (LSE: SBRY) bears the hallmarks of a risky investment. While an upbeat view suggests that the stock of the food retailer could be bought on the cheap, its valuation could get lower before it goes higher. There are a few things anybody should consider before betting on Sainsbury’s. Read on.

Restructuring Story

Sainsbury’s, the third largest food retailer in the UK, is not the most obvious restructuring play in the industry.

Tesco is a much more appealing proposition, for instance. The market leader was the first to announce price cuts some time ago. It could pursue divestments abroad or consider the separation of its domestic business from its international operations. It has options at its disposal.

Asda is planning to expand its footprint and is weathering the storm better than its three main rivals. As its web business thrives, operational changes will continue. Morrisons is in dire straits, but investment in price cuts is being promoted, and its troubles are fairly priced into the stock. Moreover, prolonged weakness in its valuation may attract opportunist bids.

The big four aside, Marks and Spencer needs solutions in clothing and homewares; no-frills supermarkets Aldi and Lidl are gaining market share; and a premium grocer such as Waitrose is holding up well.

Capex/Sales Ratio

The big four are squeezed in the middle and must adjust their price policy or shift more quickly toward a smaller format of shops, or both. Sainsbury’s is the laggard; a management reshuffle doesn’t provide a helping hand, either. How about investment?

Without investment, growth is an uphill struggle. In the last few years, the capex/sales ratio has been constantly declining.

The following trend has been recorded in the last five fiscal years: 5.11% (2009); 5.19% (2010); 5.38% (2011); 5.5% (2012); 4.58% (2013); and 3.82% (2014). Sainsbury’s capex/sales ratio is expected to hover around 3% this year, so it’s unclear how the supermarket chain can boost its growth prospects and returns. A more diverse product offering may be the answer.

Estimates: analysts’ consensus mean for revenue growth is barely in line with inflation in the UK for the next three years. Fact: the top-line has grown at a diminishing rate in the last three years.

Valuation: Nothing More Than £2.85

Sainsbury’s trades around its all-time low based on the value of the company’s capital divided by its adjusted cash flow. In a worsening competitive environment, several elements signal that its stock is fully valued and ought to be considered only if it drops to £2.85. It currently trades at £3.44.

An oft-rumoured takeover from the Middle East would offer a way out for shareholders, although there is no reason why anybody should splash out at least £10bn for an asset competing in a shrinking market. Expansion, the way we have known it for about 20 years in the UK, is out of question.

Like-For-Like

As opposed to its main competitors, Sainsbury’s is not losing market share, but its decision not to cut prices while keeping a low profile for capital expenditure could backfire. After 36 quarters of organic growth, the pinch was felt recently as sales declined.

Mid-term trends are not encouraging. According to Capital IQ S&P estimates, “same store sales growth” has been constantly in the last five years – from 4,3% to 0.2%. The speed at which it has dropped in the last 12 months is worrisome.  

Trailing leverage is lower than it used to be, so management may consider shareholder-friendly activity backed by debt. That’s a high-risk strategy when it comes to the retailing world, however.