Consumer

Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.

Britons who voted to leave the European Union may not be the only ones with buyer's remorse.

Sainsbury Suffering
The supermarket chain's shares have taken a battering in the past 12 months
Source: Bloomberg

The economics of Sainsbury's 1.3 billion-pound ($1.7 billion) purchase of Argos, the catalog and online retailer, are looking poorer after Britain's decision to head for the Brexit.

Argos pays in dollars for almost a third of the products it sells. But even for those goods it buys in sterling, the underlying price will be dictated by the movement of the dollar. That's because most of Argos's products ultimately come from suppliers in China and south Asia, which are usually paid in the U.S. currency. After the pound fell 10 percent after the referendum, those prices just got more expensive.

Argos hedges its currency exposure for 12 months, so the impact won't be felt immediately. But if sterling stays at current levels, the pain will come. Argos's parent has previously estimated every one cent move in the value of sterling against the dollar increases its cost of goods sold by 6 million pounds. That's equivalent to about 12 percent of operating profit.

Sainsbury will then face an uncomfortable choice -- absorb the cost itself or raise prices. That's going to be difficult when it is battling Amazon for customers' spending.

Indeed, it's not only the dollar that Sainsbury has to worry about. The Argos deal will make make it the U.K.'s biggest non-food retailer -- ahead of John Lewis and Amazon's British  operation -- making it more exposed to discretionary spending.

Argos was hit hard during the financial crisis, as its less affluent customers were hurt by rising food and fuel costs and stagnant wages: operating income fell by more than 70 percent between 2008 and 2012 to 107 million pounds.

Belt Tightening
Argos's operating profit was hurt as consumers'incomes were squeezed by the recession
Source: Bloomberg

With Sainsbury about to increase its exposure to largely discretionary spending, there's little wonder its shares have fallen more than Tesco -- which also has a big non-food business -- and Morrison, which is still primarily a food and grocery retailer. It is trading at a significant discount to both.

Underperforming Retailer
Sainsbury's trades at a discount to estimate earnings compared with Tesco and Morrison
Source: Bloomberg Intelligence

Sainsbury's takeover of Argos wasn't contingent on a `remain' vote in the referendum, and the company is sticking with the deal. The supermarket chain still needs to fill excess space in its stores and find a way to defend itself against the inevitable damage from its German no-frills rivals.

At least, though, there is one silver lining: Sainsbury didn't overpay. The company is paying for Argos partly with new shares, so as Sainsbury's stock has fallen, so has the purchase price. But any savings around the edges will only partly mitigate the greater pain Sainsbury is now exposed to.

This was always going to be a tricky deal to make work, and Brexit just it made even harder.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Those figures include DIY chain Homebase, which has now been sold, so the effect may be slightly more muted.

To contact the author of this story:
Andrea Felsted in London at afelsted@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net