J. Sainsbury (SBRY) reported a 1% like-for-like sales decline in the first quarter, as pricing in the U.K. grocery market remains fiercely competitive. These results were slightly below our expectations, but management refrained from altering its outlook for full-year operating profit – which we expect to decline modestly, and we don’t expect to make a material change to our assumptions or our £3.35 fair value estimate. Sainsbury shares have risen recently and now trade in line with our fair value, but given macro and competitive pressures, we suggest investors wait for a greater margin of safety.
U.K. consumers are more confident now than in the recent past, but spending in the grocery channel has yet to rebound meaningfully. We believe this discrepancy reflects the fact that although consumers are more confident, their incomes haven’t increased markedly. Cash-strapped consumers have opted to shop more frequently and buy fewer items to reduce waste, making the convenience channel an ideal shopping format; these trends are in Sainsbury's and the discounters’ favour, which have less relative exposure to larger stores when compared with rivals.
We think consumers’ habit of shopping at multiple banners and in multiple formats will continue over the long term. Switching costs are virtually non-existent in the grocery channel, which is why we do not assign Sainsbury a moat, and price competition remains fierce. Many competitors have announced intentions to invest aggressively in price, which could drive industry prices and operating margins lower over the near term. Price deflation in the industry should help resolve the gap that grew between disposable incomes and food prices, but this normalization could also weigh on near-term sales and profit margins.
Sainsbury commented that its pricing position remains strong amid a very promotional industry environment, a view that we generally agree with. The company’s Brand Match price-matching program matches against Tesco and Asda, but not discounters Aldi and Lidl. However, management believes that because Asda remains competitive relative to the discounters, price comparisons between Sainsbury and the discounters can be extrapolated based on Sainsbury’s price position relative to Asda. With about 50% of Sainsbury’s sales coming from private-label brands, comparing products across firms, including the discounters, becomes more nuanced, but Sainsbury’s reputation for quality private-label products may be driving Sainsbury’s outperformance relative to other traditional grocers.
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