Sainsburys struggles for direction

Sainsbury has not done enough to differentiate itself from competitors. It is one of the UK's ‘big four’ supermarkets, alongside Tesco (TSCO), Asda and Wm Morrison (MRW). In recent years, as discounters Aldi and Lidl have become the go-to shops for low-priced goods, all have lost market share, but none more so than Sainsbury. Since the beginning of 2017, its market share has fallen by 160 basis points, according to the latest data from Kantar Worldpanel, compared with 100 basis points for Tesco, 60 for Morrison and 40 for Asda. It now controls a similar market share to Asda and is at risk of falling from second to third place.

The UK’s challenging retail environment is well documented and it has been taking a toll on Sainsbury. Low consumer confidence in the wake of Brexit has underpinned the pressure from discounters, while a trend towards online and convenience stores has driven down footfall at high street and retail park stores. Over the past three years, the group has seen its statutory operating margin fall from 3.1 per cent to just 1.1 per cent (2.4 per cent underlying), as profits have failed to keep pace with rising sales and regular exceptional charges have been taken.

Management’s proposed solution was a mega-merger with Asda to create the largest supermarket in the UK, with more than 2,800 stores. Management argued it would allow £1bn to be invested in price reductions, leading to prices a tenth lower across a range of everyday items. The announcement caused the shares to jump, but after competition concerns led the Competition and Markets Authority to block the merger,  Sainsbury has struggled.

Despite having advocated such a drastic step, once the merger was off the table – and the group was £46m out of pocket – management opted for a decidedly understated move. Rather than overhauling the strategy it launched in 2014, it chose instead to update it, increasing its focus on its store estate and technology while adding a target to reduce net debt by at least £600m over the next three years. However, the debt target will mean a continued squeeze on capital expenditure, which has halved since 2012 and represents less than 90 per cent of the historic depreciation charge. So reducing net debt may come at the cost of further market share attrition. While the group’s current net debt figure of £1.64bn looks manageable, rent is a more significant fixed charge than interest payments, with lease obligations valued at £6bn last year.

In fairness to management, its acquisition of Home Retail Group – the parent company of Argos – back in 2016, delivered £160m in synergies ahead of schedule. But trading cannot be expected to continue to benefit from similar boosts in the future. It has shut down standalone Argos stores in favour of branches inside Sainsbury’s stores, which has led to sales growth in both Argos and in the grocery sections of supermarkets that house an Argos store.