Sainsbury’s (SBRY) shares jumped by about 5% after the company reported a first-quarter sales decline of 2.3%, as traffic and volume increased while the discounters’ growth slowed. Like-for-like retail sales declined 2.1%, primarily due to Sainsbury’s price cuts; during the first quarter, Sainsbury’s prices declined between 2% and 2.5%.
We may decrease our £2.95 fair value estimate by about 5% because of lower near-term sales growth, but we don’t expect to make a material change to our long-term forecasts.
More-competitive pricing architectures should help traditional grocers to stabilise like-for-like sales trends over the long term, although it’s too early to call an inflection point in the market. Sainsbury’s believes that its price gap over the discounters was about 20%-25% a year ago, but that the gap has shrunk by 10% over the past year.
Going forward, Sainsbury’s expects the supermarket sector to bring the gap down to 5%-10%. Discounters have fewer products – Sainsbury's estimates that 20% of its items overlap with the discounters), making it difficult for some consumers to do a complete shop at these formats; with wider price gaps, the potential cost savings are worth the inconvenience of shopping at a traditional grocer and a discounter, but with narrower price gaps, consumers are more apt to do all of their shopping at one store.
The biggest risk to our fair value is another period of aggressive price cuts and margin contraction, which could occur if the discounters opt for market share over profitability over the near term. Our base-case fair value assumes that Sainsbury’s can sustain low-single-digit sales growth and a 3% operating margin under normalised market conditions. However, given the real possibility for more aggressive pricing, we think that investors should consider purchasing this name only if they have a high tolerance for risk and a long time horizon.
