Sainsbury’s boss is getting out at the right time – so should you

The future for big supermarkets looks grim

Sainsbury’s boss Justin King is stepping down.

He’s going out on a high: the supermarket group is unquestionably in a far better state than when King took over ten years ago, and the papers have been full of praise for the man who turned it around.

But let’s not forget another supermarket boss who went out on a high – Tesco’s Sir Terry Leahy. When he stepped down in 2011, he went out as a titan of British business.

Three years on, his legacy looks somewhat tarnished. Burning more than a billion quid on trying to break into the US was a massive mistake; under-investing in the company’s core UK stores was arguably an even bigger one.

When Sir Terry left in March 2011, Tesco shares traded at over 400p – –now they’re at 320p. That’s a loss of 10%, if you include dividend payments. That’s pretty rancid given that the FTSE 100 is up 22% (with dividends) since then.

Sainsbury’s has done a little better – up 5.6% with dividends. But, like Sir Terry, I think King is getting out at the right time – the future for the big supermarkets looks grim. Here’s why…

Justin King has done a lot to turn around Sainsbury’s

Before I put the boot in, let’s look at what King got right during his tenure.

One big achievement was to get the basics right. When King took over, Sainsbury’s was having huge logistics problems. I remember occasions when I couldn’t find staples such as a can of peas in a large Sainsbury’s store.

These issues were quickly sorted and King worked to ensure that Sainsbury’s provided the food that its middle-class customers wanted. That led to 36 quarters in a row of like-for-like sales growth – an impressive achievement.

King also drove the expansion of the Sainsbury’s Local convenience store chain. It remains a lot smaller than rival Tesco Express, but it’s been a great success even so. The key point is that King was smart enough to spot that this was a genuine growth opportunity for supermarkets, unlike his counterparts at Asda or Morrisons.

King – unlike Leahy – also avoided attempts to empire build overseas, and most importantly, the chain’s market share has grown. At the end of 2013, Sainsbury’s overtook Asda to become the UK’s second-largest supermarket once again, with its highest market share since 2003.

And yet, in spite of these achievements, I’m lukewarm about King at best.


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But Sainsbury’s faces much bigger long-term problems

Here’s the big problem: profit margins are still low. In 2013, Sainsbury’s achieved an operating margin of just 3.56%. That’s the highest margin under King’s leadership. But it’s a long way behind the 5% margin Tesco regularly generated until the last couple of years.

I can see why King hasn’t wanted to hike margins too much. He’s wanted to counter the perception that Sainsbury’s offers poor value compared to the other big supermarkets. But these low margins mean that the big jump in sales under his reign hasn’t converted into a similar leap in profits.

As Andrea Felsted pointed out in the FT, last year pre-tax profits came in at £756m, not much higher than the £670m when King took over. In the end, shareholders invest for profit, and Sainsbury’s isn’t generating enough.

What’s more, recent sales performance at Sainsbury’s has only been so-so. Like-for-like sales grew by 0.2% in the 14 weeks to January, which isn’t the kind of send-off you’d expect from someone who has been an unqualified success.

The core problem is that all of the ‘big four’ supermarkets (Tesco, Sainsbury’s, Asda and Morrisons) are very vulnerable to competition from Lidl and Aldi at the bottom of the market, and from Waitrose at the top.

Online retail is also causing huge disruption. Sainsbury’s has built a decent market share in online, but we don’t know how much profit is being made, if any. As the shift to online continues, profitability could even fall.

This competition will only intensify. And as it does, it will become clear that while King did a decent job of improving the running of Sainsbury’s, he didn’t push through the sort of transformation that the big four really need to compete in this rapidly-changing sector.

Smart-alec financial engineering won’t save the supermarkets

Supermarket bulls will point to the value in Sainsbury’s property. The company’s estate is currently valued at £11.5bn, well ahead of the £6.6bn market cap. As The Sunday Times reports, some US investors are planning to push all the big supermarkets to spin off their properties into separate holding companies, from which they’ll then rent their premises.

This is the sort of smart-alec financial engineering that could give a big short-term boost to shareholder value, but could also end in disaster if the supermarkets struggle to pay rising rent bills in the future. Particularly if they’ve been loaded up with debt in the process (just look at what happened to the pub companies before the last crash).

In any case, as online shopping continues to grow, how much is a big, out-of-town retail box really worth? Perhaps not as much as the property bulls might hope.

To be clear, I suspect King’s reputation will be stronger than Sir Terry’s by 2016. But then, he doesn’t have quite as far to fall. And whatever happens, I have no intention of buying shares in Sainsbury’s or any of the other big four. There’s too much competition and not enough growth.

The grim reality (for the supermarkets, if not their customers) is that there are too many of them, and there needs to be a massive, probably painful, shake-up of the sector before they might be worth considering as value plays.

For now, there are far more exciting stock market opportunities elsewhere – Japan, small caps, commodities – even some of the better emerging markets. Even if you’re looking for dividend income, there are better options elsewhere – try big pharma, or even big oil.

And if you really want to buy into UK retail, I’d stick with a company like Next (LSE: NXT) – it’s not cheap, but in terms of business strategy, it’s almost impossible to fault.

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10 Responses

  1. 30/01/2014, Leapo wrote

    I read your mad article yesterday that suggested that it was good idea to short AAPL as they were finished! The whole piece lacked any kind of meaningful financial back up to support this view and indeed, it simply implied that AAPL would sit back and do nothing for ever more. It also brushed aside the colossal earnings achieved, and the even larger cash pile they are sitting on. Yet the article asked us to believe that AAPL was no better than Ryanair. Come off it. That’s taking it too far. AAPL never ever said that they were a discount retailer for goodness sake.

    However, now I know the lunatics have taken over the asylum!

    This article I read this morning from what pupports to be a grown up magaine for investors: “Sainsbury’s boss Justin King is stepping down,” shows that you have taken leave of your senses.

    It’s the last bit that is absolutely off the scale in lunatic comments. After making some decent suggestions, you suggest that we should buy NXT if we must have exposure to UK retail. It has a miserable Div and is at the top end of pricing after increasing from £40 to £62 in 12 months. Who on earth in their right minds is going to buy NXT if the economy is so skewed that Sainsbury’s is doomed. Besides, their share price has increased from a heady £40 to around £62 in the last 12 months which doesn’t scream “good time to buy!” And why sell Sainsbury’s in order to “benefit” from NXT? After all, people have to eat, they don’t have to buy over priced preppy rags. Had the author suggested ABF, ULVR or perhaps DGE (have people suddenly stopped drinking around the world?), then I would have had slightly less angst about this article.

    I appreciate that you are entitled to an opinion and Sainsbury’s is indeed operating in a congested operating space. I also appreciate the fact that NXT is a fine business. But is it a good investment right now? If the market is so precarious that you can justify selling Sainsbury’s as a dead business model, buying NXT on these valuations is madness.

    • 30/01/2014, gamesinvestor wrote

      Pretty good summary. In a world of low no growth all the overpriced stocks mentioned in the article will be a drag for years possibly, yet Supermarkets are not dying, they are indeed in a competitive environment but still they take the lions share of consumer spend – between Tesco, Sainsbury and Morrisons.
      Of the three I would avoid Sainsbury because it has limited scope with such low margins at 3.3%.
      The ROCE and operating margins are far better at MRW and TSCO.

      Either of these can be bought at 2008-9 prices and yields close to 5% that will probably be maintained or grown for years.

      No I think you are right, MWeek have made a wrong call here!!

  2. 30/01/2014, TJ13 wrote

    400-320=80
    80/400 *100 = 20

    Tesco has dropped 20% not 10%!

    • 30/01/2014, gamesinvestor wrote

      add back the dividend and it’s about 10% – I think that’s what the article alludes to.

  3. 30/01/2014, Pinkers Post wrote

    Yes, we are losing appetite. But selling Sainsbury’s? Retailers are clearly OUT, especially the traditional ‘big four’ food retailers, and John Lewis is not for sale… but selling Sainsbury’s at this stage would be daft. The price is firmly underpinned by continued takeover speculation and with Quatar owning 26% and the family shareholding now immaterial, there will inevitably some kind of new ‘arrangement’ in the not so distant future – probably coinciding with Justin King’s departure. Furthermore, there is the property portfolio, valued well in excess of the company’s market cap. The pension fund might pose a little hurdle but no more than that and certainly not the major obstacle it proved when the retailer was last on the shopping list in 2007. Sainsbury’s is not a buy right now – very little is – but investors should keep a firm grip on their holdings!

    pinkerspost.com

  4. 30/01/2014, Pinkers Post wrote

    Previous comment posted before King’s departure, obviously. Pinkers got the ‘arrangement’ wrong but the situation hasn’t changed. In fact, Sainsbury’s is now MORE vulnerable!

    pinkerspost.com

  5. 30/01/2014, gamesinvestor wrote

    This quote made me laugh so much — “”"”For now, there are far more exciting stock market opportunities elsewhere – Japan, small caps, commodities – even some of the better emerging markets. Even if you’re looking for dividend income, there are better options elsewhere – try big pharma, or even big oil.”"”

    Let’s look at each of these suggestions and then rethink supermarkets:-

    JAPAN- falling yen and a ballooning debt to GDP that will never be resolved. “Investing here is like picking up dimes in front of a steam roller”
    COMMODITIES- With a China shifting toward buying Burberry and not constructing buildings, where is the impetus to drive up copper and iron ore prices?
    EMERGING Markets – Given that QE has only just started it’s prolonged tapering exercise, how far do you think emerging currencies will fall – the answer is very low indeed – wiping out most equity investment.
    SMALL CAPS – Don’t make me laugh – small caps have massively outperformed large caps over the last years. Now what gets hit hardest under a liquidity squeeze?
    BIG PHARMA – interesting, perhaps the best suggestion if not a little late to the party. But at least they have credible balance sheets.
    BIG OIL – Now with profits declining at the time when oil has been up at $120-140 a barrel, are they going to improve at $80 level which is a consensus direction for the price? Look at Shell it is forced to sell off the family silver to keep paying the overinflated dividend. BP is now almost uninvestable with no support or grant for US business and a litigation trail that is indeterminate at this stage.

    Even taking the top consumer durables Diageo-Unilever-RB, you have 5 year stock market valuations in the stratosphere.

    Yet you look at the supermarkets and you see a flat, or at least a share price returning to 5 years ago – yet these businesses have all still grown, have suffered competition but still take the lions share of the consumption in the UK.
    With yields approaching 5% or greater and cover approaching 2% in the case of Tesco and Morrisons you have a potential forward annualised return here of 10% +.

    I’ll take that thank you – and you can stuff your emerging markets Japan and Big Oil in the drawer for another day.

  6. 30/01/2014, gamesinvestor wrote

    Rabster – frustrating isn’t it? The information after each “Here’s why” is getting rather thin on research.
    What was it Terry Smith said in one of his speeches – when you hear the word expert, start walking the other way :)

  7. 01/02/2014, Ben Dover for Taxes wrote

    Maybe it is simpler than all that and he has just been offered a bag of gold?
    Rumours are circulating that Justin King has been named as a potential to take over from F1 Supremo Bernie Ecclestone if his court case goes against him.

  8. 14/02/2014, John wrote

    When has Waitrose -ever- been at the top?

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