Sainsbury's Offer to Buy Argos has Risks, say Analysts

Supermarket stock Sainsbury's has announced an offer to buy Home Retail Group, owner of Argos and Homebase, equity analysts remain unconvinced by the deal

Ken Perkins 2 February, 2016 | 3:21PM
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Sainsbury’s (SBRY) announced an offer to acquire Argos owner Home Retail Group for £1.1 billion, and we expect to lower our £2.70 fair value estimate for Sainsbury slightly by less than 5% as a result of valuation and structural pressures at Argos. Sainsbury expects to generate about £120 million in annual synergies by the third year after the acquisition's close.

We see the rationale for the deal... but we will not change Sainsbury's no moat

About £40 million of the savings is expected to be achieved from cost reductions, while about £60 million is expected to come from concessions from the Argos chain and £20 million from additional revenue synergies.

However, given the risks around achieving synergies, we suggest that investors look to Tesco instead of Sainsbury.

We do see the strategic rationale for the deal. Sainsbury's strategy is to tap into the 40% of consumers who have shopped at both Sainsbury's and Argos by cross-selling food and non-food. Underlying this motive is Sainsbury's aim to provide a full assortment of food and general merchandise via an omnichannel model.

Sainsbury's goal is representative of the general brick-and-mortar response to e-commerce, and we think it is a logical one given that around 50% of online general merchandise sales are click-and-collect orders. Sainsbury believes that 6% of its square footage, or about 1.5 million square feet, is underutilized, giving the company an opportunity to incorporate Argos stores into its own stores.

Still, we do not expect to make a change to our no-moat rating for Sainsbury. We believe Sainsbury has a solid core grocery portfolio with midsize stores, convenience stores, click and collect, and a discount banner with Netto. This deal carries the opportunity to sell both grocery and general merchandise, but it also exposes Sainsbury to greater competition from other e-commerce firms in the general merchandise space. We do not believe that Argos has a competitive advantage over rivals, and as such, our moat rating is unchanged.

We also believe the deal contains execution risk. Our base-case fair value estimate assumes that Sainsbury delivers on its synergy targets, as it has had a chance to test Argo chains within its stores. However, if Sainsbury fails to generate deliver on its synergy targets, we would probably decrease our fair value estimate.

We believe the range of possible values for revenue synergies is high, and failure to achieve them will put additional downward pressure on results. Moreover, even if Sainsbury generates synergies, weak growth due to intense online competition could still cause sales to be lower than expected.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Sainsbury (J) PLC258.80 GBX0.00Rating

About Author

Ken Perkins  is a Morningstar equity analyst covering consumer packaged goods firms.

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