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Sainsbury‘s (LSE:SBRY) made headlines this week by announcing its entry into the prestigious ‘£1bn Club’. It sending its shares higher in the process.
On Thursday (17 April), the FTSE 100 grocer said retail sales (excluding fuel) rose 3.1% in the 52 weeks to 1 March, to £31.6bn. This in turn propelled retail underlying operating profit through £1bn for the first time, and up 7.2% year on year.
Celebrating “a record-breaking year in grocery“, Sainsbury’s said it had “outperformed the market every quarter for a second consecutive year and making our biggest market share gains in more than a decade“.
The retailer’s resilience in a competitive sector and in light of sustained pressure on consumer spending is no mean feat. However, with it warning of storm clouds on the horizon, can Sainsbury’s profits and share price keep up their recent momentum?
Back down to earth
In recent years, Sainsbury’s has got back to doing what it does best by focusing on its core grocery operation. One key lever has been slicing prices to compete better with the value retailers (£1bn has been invested in this over the past four years).
It’s a strategy that’s paid off handsomely more recently. Sales across its Sainsbury’s-branded shops and website rose 4.2% last financial year, to £26.6bn. But while food revenues rose 4.5% year on year, clothing and general merchandise sales collectively flatlined.
With consumers tightening the purse strings, it’s perhaps no surprise that non-food lines struggled. Stress was particularly pronounced at Argos, where revenues dropped 2.7% to £4.9bn.
Given the economic landscape, I’m not expecting general merchandise sales to pick up any time soon. While this could remain a huge drag, it may not be critical to Sainsbury’s investment case if it can continue to make progress on the food side.
Unfortunately this isn’t the case. Illustrating the rising challenges for its core operation, the retailer said it expects underlying retail operating to stagnate at around £1bn.
Under pressure
This subdued projection is perhaps no surprise. Supermarkets face a worsening blend of increasing competition and rising costs that are putting their wafer-thin margins under extreme strain.
Like those of rival Tesco, Sainsbury’s shares dropped sharply in March after Asda — the UK’s third-largest chain — vowed to launch its biggest price cuts in a quarter of a century. With Tesco pledging to invest in prices in response, the starting gun has been fired on yet another profits-crushing price war.
Sainsbury’s has two choices: it can row back on its recent value strategy and risk losing customers. Or it can reduce price tags and see its underlying operating margin (which was a thin 3.17% last year) crumble. Either way, things don’t bode well for the bottom line.
Today Sainsbury’s shares trade on a forward price-to-earnings (P/E) ratio of 12.3 times. I don’t think this low enough considering the huge challenges the company faces. So I’d rather find other UK shares to buy right now.
