Could Sainsbury’s go bust?

With so much news-driven share price moves for the average stock these days, it is often easy to overlook the base financials of a company. To the uninitiated, a company’s financial report can be intimidating, and headlines about revenue or EBITDA can be the extent to which some investors look at the numbers. However, one metric I like to use to gauge a company’s strength is known as the Altman Z-Score.

This calculation is effectively a credit strength test that gives a listed company a number based on five key financial ratios. As a rule, anything above 3 is pretty solid, while anything below 1.8 is a riskier prospect. Of course the number needs to be taken in context, and should always be viewed in relation to a sector or industry average.

Below I have calculated the Z-Score for J Sainsbury (LSE: SBRY), then compared it to similar firms including Tesco and WM Morrison, and the results were very telling. These numbers are based on the companies’ most recent full-year reports.

Looking at the figures, the first thing worth noting is that the supermarket industry as a whole seems to verge on the 1.8 benchmark figure, while Sainsbury’s falls just below the number.

While I am certain the increased dominance of online retail is hitting bricks-and-mortar stores hard, I think it is fair to say this low figure is more a result of specific differences in supermarket financial reporting, such as holding stock for sale, than the industry being on the brink of mass bankruptcy.

Given the pressure Sainsbury’s shares have been under recently, it is no surprise that its market value of equity is subdued, and a key component in why its Z-Score falls below that of its peers. If its share price were that of 12 months ago, the number would be much closer to the average (though still below it at about 1.7).

By the company’s own admittance, its latest earnings have been hit by last year’s unseasonably wet and cold summer, with sales in its general merchandise and clothing departments taking the biggest hits – T-shirts and sun loungers seeing less demand when the sun isn’t shining.

As I said earlier, a broader move away from the traditional (high street retail) to the new (the online world) is hitting the supermarket industry as a whole. However unlike other sectors seeing such changes (the TV industry, for example), I think it is very unlikely that the transition will see physical retail disappearing (at least, not for a very long time).

While I can foresee almost all consumers of TV shows eventually moving to streaming and downloads, the nature of supermarkets and grocery shopping means, I think, there will always be a need for actual stores in one capacity or another.

Of course a key component for supermarkets to survive this change will be adapting to online business models and partnerships – something that all the major retailers are currently attempting to do. Sainsbury’s may not have the strongest Z-Score, but I cannot see it going bust anytime soon.