Sainsbury's makes progress against the discounters

J Sainsbury (SBRY) shares gained 5 per cent on results day after it raised full-year guidance on the back of “record market share gains” against grocery competitors. The UK's second-biggest supermarket now expects retail free cash flow to hit at least £600mn, up from its previous forecast of £500mn, and guided that underlying profit before tax will fall within a range of £670mn-£700mn compared with a prior estimate of £640mn-£700mn.

A contraction in interim pre-tax profits was due to technical factors such as the impact of legal income last year, rather than anything more nefarious. The company booked £30mn in the comparative period for the settlement of issues relating to overcharges from payment card processing fees, with no such income flowing through this time.  

Sainsbury’s, along with peers such as Tesco (TSCO), is locked in a battle for custom with the German discounters Aldi and Lidl, which are growing quickly as shoppers trade down. The company’s investment of £118mn since March to keep prices down seems to be helping it fight back, as does the rollout of Nectar Prices, a scheme that offers shoppers personalised prices. Grocery sales were up by 10.1 per cent in the period, with volumes in growth across both quarters.

It wasn’t all good news for the top line, though. Unhelpful weather hit general merchandise and clothing performance, with sales rising by 1.1 per cent and falling by 8.4 per cent, respectively. While Argos saw growth across the half, its performance has been mixed for some time, and sales fell by 3 per cent in the second quarter.

Over at the financial services division, operating profits fell from £19mn to £13mn year on year after the mortgage book was sold during the half.

Elsewhere, leverage fell from 2.9 times to 2.6 times year on year. This benefited from a property transaction which reduced lease debt by over £1bn, and sits comfortably within the company’s target range of 2.4 to 3.0 times.

House broker Shore Capital forecasts a notable free cash flow yield of 9.8 per cent for the full year and argued that Sainsbury's balance sheet is "an increasingly strategic competitive advantage in UK grocery". 

The valuation remains undemanding, in our view. The shares trade hands at 12 times forward consensus earnings, according to FactSet, which is in line with the five-year average. A strategy update in February next year will be eagerly awaited by investors, but in the meantime the company is making cautious progress. Hold.

Last IC view: Hold, 280p, 28 Apr 2023