Sainsbury’s recovery looks distant

Prior to lockdown, the group’s strategic progress had not been as bad as many had feared following an expensive failed merger with Asda 18 months ago, which left Sainsbury looking both directionless and overindebted. Trading has benefited from a renewed focus on ‘value’ and property sales have helped reduce borrowings. 

However, the coronavirus pandemic presents a host of new potential problems, including downward pressure on margins; a potential hit to discretionary non-food sales; and the possibility of major losses at its bank as borrowers struggle to repay loans. 

Sainsbury operates more than 1,400 supermarkets and convenience outlets in the UK, as well as running a bank and Argos. Groceries account for nearly two-thirds of revenues, while almost a fifth of all sales were conducted online in the year to March. 

While Sainsbury’s saw retail demand surge during lockdown, with first-quarter like-for-like sales 8.2 per cent ahead, benefits from increased activity are expected to be eliminated by at least £500m of pandemic-related costs. The group has also been forced to delay store investment, which could negatively affect future performance. The surge in grocery demand has been led by less profitable online sales more than doubling. This shift will dilute Sainsbury’s already thin margins, with the group incurring additional costs including investment in technology and distributors. The trend towards less profitable online sales may well persist. 

Meanwhile, competition from discounters such as Aldi and Lidl has not disappeared, either. During the past five years, Sainsbury’s share of the UK grocery market has gradually declined from about 17 per cent at its peak to below 15 per cent based on Kantar data. As consumers struggle with the financial repercussions of the pandemic, its position at the pricier end of the supermarket spectrum could see it lose more shoppers to cheaper rivals. Its reliance on more discretionary non-food sales for 27 per cent of turnover, which was increased by its acquisition of Argos four years ago, also makes it more vulnerable to any economic downturn.

The group’s struggling bank business could also face big losses in a post-pandemic recession. It has already proved a major drain on capital, requiring injections of £35m last year and £110m the year before. Broker Berenberg believes a further £350m could be needed over the next three years as bad debts emerge from the loan book, which stood at £7.4m at the end of last year. Sainsbury, which stopped writing mortgage business last year, has reined in loans during its first quarter. While this should help conserve capital, as a long-term strategy it would also hit the bank’s profitability, adding to the impact on banking profits from low interest rates.

Added to these headwinds is Sainsbury’s stretched balance sheet. Net debt at the end of the last financial year stood at £6.9bn, which includes £5.8bn in lease liabilities. While this was down from £7.3bn in the previous year, helped by £143m of dividends following store disposals by a property joint venture, it still represented over three times cash profit and1.7 times the current market cap.