For My Next Trick...

Sainsbury Pulls Another Rabbit From its Hat

Coupe will struggle to repeat this trick.

The day has been (partly) saved for J Sainsbury Plc -- this time, its Argos division has defied the critics by turning in a decent performance. But the unit may be unlikely to repeat the trick in future, given the pressures mounting for Britain's second-biggest supermarket chain by market share.

The company said Wednesday pre-tax profit before exceptional items fell for the third consecutive year, while sales from the core supermarkets slipped almost 2 percent in the year to March 11. At Argos, same-store sales rose 4.3 percent in the final quarter of the financial year, and it contributed underlying pre-tax profit of 77 million pounds ($99.5 million), ahead of the company's previous guidance of 55 million to 75 million pounds.

For Sainsbury, life is about to get tougher, and Chief Executive Officer Mike Coupe's job looks increasingly like one of managing decline. Even before the Argos deal, its margins were thin, and it looks like they've shrunk even further, to 2.42 percent. 

Wrong Direction

Sainsbury's pre-tax profit before one-off items has fallen for the third successive year

Source: Company reports

Argos's profit figure would have been struck before the full effects of the slump in sterling were taken into account, as the company would have been hedged at more favorable exchange rates. Managing the hit from sterling-induced price inflation will become more difficult from here as these hedges roll off and shoppers look unwilling to accept higher prices.

Sainsbury will surely need the 160 million pounds of annual forecast cost savings from the Argos deal -- which it says it will achieve six months ahead of target -- to defend its margins. But this won't be enough to counter the prospect for further shrinkage, and it will certainly be a stretch to expand them, as might have been expected given  the addition of higher-margin home furnishings and clothing to a supermarket range.

Not Much Wiggle Room

Sainsbury's thin margins leave it exposed to cost inflation

Sourc: Company reports, Bloomberg

There are other hurdles ahead. Sainsbury is exposed to a squeezed consumer, both in its core supermarket business and at Argos, whose less well-heeled customers reined in spending the last time inflation spiked.

It also faces increasingly muscular rivals, particularly if Tesco Plc succeeds in acquiring wholesaler Booker.

True, Sainsbury has been bringing its borrowings under control, partly as the Argos deal shifted some of its debt off balance sheet. Net debt fell by 349 million pounds to 1.48 billion pounds in the latest year. In addition, the company's followed through with a pledge to cut its dividend, so it's moved further away from the prospect of an emergency rights issue.

So far, investors are giving Sainsbury the benefit of the doubt. Notwithstanding the 5 percent fall in the shares on Wednesday, they are up 17 percent since the beginning of December, narrowing the gap with Tesco and Wm Morrison Supermarkets Plc. Short interest has also fallen substantially. 

Coming Up Short

Short interest in Sainsbury has halved as investors have warmed to its Argos purchase

Source: IHS Markit

The risks both to Argos and Britain's grocers mean that Coupe will need to pull another rabbit out of the hat to justify that rerating. Given that the company has made outsmarting its critics an art form, he stands a good chance. But the coming storm might prove too much for even this perennial defier of doom. 

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

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    Andrea Felsted in London at

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