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28 January 2025

Sainsbury's

While Tesco is the comfortable leader of the UK grocery market, Sainsbury’s has been gaining market share in recent years through a combination of product innovation and competitive pricing, now holding second position. With companies still digesting the implications of the recent Autumn Budget, investors are keenly watching the execution of Sainsbury’s £1bn transformational cost saving initiative.

In February 2024, Sainsbury’s presented its Next Level strategy, setting out its operational approach for the next three years. It promised a renewed focus on the grocery business following a spree of shakily executed ventures into other markets, putting food back at the heart of the business. The goal is to offer greater choice of groceries with consistent value, availability, and innovation across stores to attract more customers to shop at Sainsbury’s on a regular basis. It is building the range of its premium own label brand Taste the Difference, with product innovations catered to changing consumer tastes. The company launched over 540 new products in the first half of 2024.

Beyond the grocery business, management has emphasised that the company’s other products and service should reposition as complementary to the core offering. This includes the clothing line Tu, retail company Argos, and furniture store Habitat.

The renewed focus on food has included selling most of its banking business to NatWest following a failed foray into financial services. It also sold the Argos credit card business to credit provider NewDay Group.

The retail division Argos is well known for its affordable and broad range of products, as well as its traditional high street catalogue stores, though most transactions now occur online. Sainsbury’s acquired the company in 2016, and integration has been challenging given the differences in the businesses and target customers. In 2020, Sainsbury’s announced that 420 Argos stores would be closed and 3,500 jobs cut, with a shift to outlets and collection counters within the grocery stores. Moving forward, the company is targeting improved service, efficiency, and stock flow at Argos, in addition to modernised, smaller stores offering an improved customer experience. The division has had a difficult 2024 driven in part by poor summer weather, but management is anticipating stronger performance in the second half its financial year.

On the financial side, Sainsbury’s is targeting £1bn in structural cost savings over the next three years to improve margins and drive robust profit delivery. This will partially be accomplished through investment in a strong technology platform and simplified automated processes. developing the electric vehicle (EV) charging network. As the cost of running a Sainsbury’s store is largely fixed, increasing the volume of sales should improve margins and returns.

The business strategy is supported by a commitment to improved shareholder returns, including introducing a progressive dividend from next year having previously based payouts on 60% of underlying earnings. It is also undertaking a £200m share buyback program in 2025.

In the six months to September 2024, Sainsbury’s reported good progress on strategic targets. Market share is increasing, with sales (excluding fuel) increasing by 4.6% with total underlying operating profit before tax up 4.7%. The Taste the Difference range performed particularly strongly, with an 18% increase in sales. Strong execution has driven a shareholder return of 12.7% over the month to 11th December, and an attractive dividend yield of 4.8%.

However, over the longer-term investors remain cautious with year-to-date share price returns of -8.30%. The Autumn Budget will impact operations, especially the hike in National Insurance (NI). The current level of 13.8% on salaries above £9,100 is set to increase to 15% on salaries above £5,000. Given that Sainsbury’s has a large base of part-time and minimum wage employees, it is particularly vulnerable to higher labour costs. The company has guided a £140m increase in expenditure from the NI increase alone, not including the impact of a higher minimum wage. Sainsbury’s management anticipates that this will feed into higher prices for consumers, especially given that the supermarket industry is notoriously low margin. In the 2024 financial year, Sainsbury’s, Tesco, and Morrisons reported an average operating margin of 3.0%, with Asda lagging at 1.7%. The discounters Aldi and Lidl reported even tighter margins, averaging 0.7%. Low margins mean the industry will struggle to absorb the increased labour costs without increasing prices.

This pressure on Sainsbury’s was exacerbated in October when its biggest shareholder, the Qatar Investment Authority, sold £306m worth of shares pushing the share price down nearly 5%. However, the business fundamentals remain strong, and the recent improved performance potentially indicates improving investor sentiment. Given the industry pressures moving forward, Sainsbury’s transformational cost-cutting strategy and focus on innovation in the core food business seems well-timed. Christmas is a critical time for both groceries and the Argos retail line. Moving into 2025, investors will see if Sainsbury’s is able to balance additional wage pressure and intense competition with attractive shareholder returns.

Please note that this communication is for information only and does not constitute a recommendation to buy or sell the investments mentioned. Investments and income arising from them can fall as well as rise in value. The information and views were correct at time of publication but may have changed at point of reading.
Sainsbury's
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