The recent disclosure of a £1bn bid by J Sainsbury Plc (LSE:SBRY) for Home Retail Group Plc, the owner of Argos and Homebase, comes at a critical juncture for the grocer as it faces declining profits due to shifting consumer habits and price wars with rival grocers.
On the face of it, the deal may be an astute one. As shoppers increasingly buy online or at smaller convenience branches closer to home, then Sainsbury’s out-of-town big box supermarkets are consistently facing declining sales and margins. Converting some of the hundreds of Argos high street locations to Sainsbury Locals and taking advantage of Argos’ enviable countrywide same-day delivery service would allow Sainsbury’s to keep pace with nimbler competitors.
Big mistake?
Despite having the balance sheet to be able to execute this deal, I believe it would be a mistake for Sainsbury’s to make another bid. Proponents of the deal will point to the relative success of non-grocery items and the 10 existing Argos locations inside Sainsbury’s supermarkets. But there’s no reason this partnership can’t be expanded without spending over £1bn to acquire a struggling retailer while simultaneously attempting to protect its core grocery business. Over the past six years, Argos sales have fallen 6% while operating profits have more-than-halved as the former catalogue-based retailer has lost ground to the likes Amazon.
Sainsbury’s would be better off continuing to expand its more upmarket own store brands and roll out more click-and-collect shopping locations. It would also do well to forge partnerships, such as that with Argos, to drive more traffic to out-of-town supermarkets. Combining two struggling companies in different sectors doesn’t often make a recipe for success and I see little reason to believe it would be different in this case.
Good deal
Pharmaceuticals specialist Shire Plc (LSE:SHP) is another FTSE giant with its eyes on major acquisitions. Talks continue over the $32bn deal for US-listed Baxalta, which would create the world’s largest rare disease specialist. Shire’s long-term plan to focus more on these high-margin speciality drugs is a sound one as they require lower overheads, rarely have competitors, and some 90% of classified rare diseases have no current treatment.
While Baxalta’s core business of haematology faces possible competition from Bayer and Novo Nordisk, its current options have proven more resilient than expected and its pipeline remains well-stocked to ensure continued market leadership. Shire’s approach for Baxalta, alongside smaller deals, is necessary to reduce the company’s reliance on Attention Deficit Disorder treatments. Although analysts are predicting the Baxalta deal could be 30% to 40% cash, Shire continues to print cash quarter-after-quarter, to the tune of $539m in free cash flow for Q3. And in recent years, management has proven its ability to effectively work debt off the balance sheet.
Shire doesn’t offer the dividend of a GlaxoSmithKline or AstraZeneca but trading at 12 times this year’s earnings and with significant growth prospects ahead, I view the company as an attractive investment for the long term.