Marshall Wace Bets Grocer Sainsbury May Need Rights Offering

J Sainsbury Plc may need a rights offering as margins shrink amid fierce competition among U.K. supermarket operators, according to Marshall Wace LLP, a U.K. hedge-fund firm that’s betting on a decline in the company’s shares.  

“Sainsbury’s balance sheet leaves it in a precarious position,” Marshall Wace wrote in a letter to investors sent Wednesday and seen by Bloomberg News. The company, one of Europe’s biggest hedge funds, sees the “potential need for a rights issue if margins compress as we believe they will." A Sainsbury spokeswoman declined to comment. 

While Sainsbury generates substantial cash, there’s a risk to this from both a potential “step down” in earnings and the prospect of higher payments to narrow the company’s pension deficit, the London-based money manager said in the letter for MW Global Opportunities Fund managed by Fehim Sever. “On top of the balance-sheet issues, Sainsbury carries substantial lease liabilities." A spokeswoman for the hedge fund, which managed $25.7 billion at the start of 2017, declined to comment further. 

Intense competition in the U.K. grocery sector has forced Sainsbury and its traditional rivals into years of price cutting in an effort to lure back customers who have defected to discounters Aldi and Lidl. Sainsbury’s slow sales growth has been compounded by rising costs as a result of a new national minimum wage and an imminent increase in business rates -- a tax levied on commercial property.

Marshall Wace, which is 25 percent-owned by KKR & Co., raised its short bet on Sainsbury shares earlier this month to just under 1 percent of outstanding shares valued at about $65.9 million, according to data compiled by Bloomberg. Short sellers profit by selling borrowed shares and buying them back at lower prices.

Marshall Wace said that Sainsbury is unable to raise prices and a weaker pound is driving up costs. The acquisition of Argos, which competes directly with Amazon.com Inc., has also hurt the company’s pricing power, the hedge-fund firm said.

“While some people believe that re-inflation is good for the industry, we are firmly of the belief that costs will increase more than pricing can and, as a result, margins are likely to be squeezed," according to the letter.

Initial investor skepticism over the strategic merits of the 1.4 billion-pound ($1.7 billion) Argos deal was exacerbated by the pound’s plunge in the wake of the U.K.’s Brexit vote, which will lead to higher sourcing costs at the general merchandise chain.

Pension Deficit

Sainsbury’s pension deficit almost tripled to 1.31 billion pounds in September from a year earlier, fueled in part by the acquisition of Argos.

Sainsbury’s is not the only U.K. grocer to have had its financial health questioned since the incursion of Aldi and Lidl. Over the last 18 months, analysts have speculated that market leader Tesco Plc, which lost its investment grade credit rating, could be forced into a rights issue.

In November, Sainsbury said that maintaining a strong balance sheet is one of its four key strategic priorities. The company expects its net debt to be about 1.5 billion pounds at the end of the current financial year.

Short interest currently stands at 11.3 percent of Sainsbury’s shares outstanding -- the third highest of any FTSE 100 company, according to data from Markit Ltd. The company’s short interest has not dropped below 10 percent of shares outstanding since 2014.

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