Missing the Boat

This Sainsbury Plan Made Sense...in 2014

Marshall Wace should have tried in 2014, when things looked much worse.
As of 4:19 AM EDT
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Marshall Wace LLP is either two years too late or too early in its charge at J Sainsbury Plc.

The hedge fund warned Wednesday in a letter to investors that the company may need a rights offering, according to Bloomberg News, which estimated its short position at just under 1 percent of outstanding shares.

The timing looks off. There have been occasions over the past few years when Sainsbury has looked far more at risk of an emergency capital raising.

Sainsbury has always had one of the weakest balance sheets of the big four supermarkets -- the others are Tesco, Wal-Mart's Asda and Morrison -- often in previous years paying its dividend out of borrowings.

But right now, its financial stability is improving.

Sainsbury's acquisition of Argos last year strengthened its balance sheet, thanks to its 322 million pounds ($402.3 million) of cash and its 615 million-pound customer loan book. Sainsbury's net debt was 1.8 billion pounds at March 2016, and the company is forecasting March 2017 net debt at 1.5 billion pounds.

Come on Down

Sainsbury's net debt has fallen on lower capital expenditure and the purchase of Argos

Source: Company Reports

Synergies are set to come through from the Argos purchase, and early sales indications have been surprisingly positive. Gadfly has long argued that Sainsbury should have left Argos on the shelf, as the purchase could distract from fighting off competitors. But there was little to fault in the financial aspects of the deal.

Big Spender

Sainsbury typically has strong cash generation, but much of this has been reinvested in stores. Lately, it's been cutting capital expenditure.

Source: Bloomberg

All in all, Sainsbury looked far more vulnerable to a rights offering in late 2014, when it was still shelling out 1 billion pounds a year in capital expenditure, and the supermarket price war was in full swing. Since then it has curbed its spending and cut its dividend.

While the company certainly faces risks, they're mostly problems for the future.

Argos heightens its exposure to the slump in sterling, as most of its products ultimately come from suppliers in China and south Asia, which are usually paid in dollars. The pain from a strengthening dollar could turn out to be more extreme, as hedges will run out over the next few months. At the same time, faster inflation could curtail consumer spending. 

Under Pressure

Sainsbury's operating margin has held up better than rivals, but is forecast to fall over the next two years

Source: Bloomberg

Competitive pressures abound. Amazon could launch a fresh assault on the U.K. market. There is also a danger closer to home, as Tesco's buying power may strengthen if it completes its 3.7 billion pound acquisition of Booker. Meanwhile, Asda may ratchet up the supermarket price war once more, as it seeks to stem its sliding sales.

Sainsbury is also exposed to increases in rental costs, as it owns about 60 percent of its stores, compared with 85 percent at Morrison. And it has a punchy pension deficit, at 1.31 billion pounds for Argos and Sainsbury. Its triennial valuation, which determines how much money it must put into the plan, isn't until 2018, and that could go either way. 

At the same time Sainsbury's operating margins are forecast to fall over the next two years, according to Bloomberg consensus. That's not a great place to be when costs, including business rates, are rising.

Not Bothered

Sainsbury investors have shrugged off claims of a need for a rights offering

Source: Bloomberg

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But Sainsbury has made a habit of defying the doomsters. And if things do deteriorate, it has other levers that it can pull, such as pruning the dividend further -- although there's no sign of that at the moment -- and taking more of an ax to costs. It is likely to pursue those courses of action before tapping shareholders.

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

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

    To contact the editor responsible for this story:
    Jennifer Ryan at jryan13@bloomberg.net

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