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Stock Watch: Sainsbury’s, Morrisons and Primark-owner ABF

Emma-Lou Montgomery

Emma-Lou Montgomery - Fidelity Personal Investing

After Tesco recently announced the shock departure of its chief executive and a rise in first-half pre-tax profits, it’s the turn of Wm Morrison Supermarkets and J Sainsbury.

The UK’s second-biggest supermarket chain, J Sainsbury (SBRY) is expected to announce that it is exiting mortgage lending, in a move to improve the profitability of its banking unit and conserve capital.

It certainly needs to set out its stall after its failed takeover bid for rival Asda.  It had planned to acquire Asda and use the resulting scale to reduce its buying and operating costs, but competition regulators blocked the deal this year.

Offloading its mortgage business is something that Tesco has also done; recently completing the £3.8 billion sale of its mortgage book to Lloyds, in a bid to simplify its product ranges and reduce funding costs. 

Sainsbury’s mortgage book comes in at £1.47 billion, about a fifth of its total lending. Although “ringfencing” rules that became effective at the start of 2019 don’t affect Sainsbury’s, because it has less than £25 billion in deposits, they have resulted in increased competition in the mortgage market and a squeeze on margins; hence the reason for all these non-financial players beating a hasty retreat.

Sainsbury is expected to refocus its bank on providing less capital-intensive services — like insurance and credit cards — and primarily to customers who are members of its Nectar loyalty card scheme. That way it side-steps the need to pay expensive commission to the price comparison websites, and so on, that it currently relies on to drum-up new business.

Analysts have been asking questions about the viability of Sainsbury’s banking arm for some time now. Originally established as a joint venture with the Bank of Scotland, Nick Coulter an analyst at Citi has calculated that since spending £248 million taking control of the bank in 2013, Sainsbury’s has put in almost £700 million of additional capital to support lending and spent more than £650 million on IT and other costs.

The bank made a £34 million loss last year, though a profit of £45 million is forecast for the current year.

At the full-year results in May, group finance director Kevin O’Byrne acknowledged the “disappointing” performance of the bank and said the company was examining ways to limit the capital required. However, he said there were no plans to sell the bank.

Sainsbury’s is also likely to focus investors’ minds on the growing role of customer data. In 2018, it paid £60 million for the Nectar loyalty card scheme, of which both it and Argos are members, and it needs to show that can add value to the bottom line too.

Analysts also expect updates on cost reductions, and more on the supermarket’s plans to make its pricing more competitive — one of the main reasons for the Asda deal. 

Over the summer, Sainsbury’s used price cuts, coupon offers and petrol promotions to help lure customers through its doors and rebadged some products in its entry-level “Basics” ranges. That appears to have paid off as recent data from Kantar show it has reduced market share losses. So much so that in the past two 12-week periods under review, it was the best-performing of the big four supermarkets.

A September trading update showed that sales had indeed edged up in the second quarter too, but fell on a like-for-like basis. Sales growth of 0.6% in grocery was offset by a 2% fall in general merchandise.

The company has said it expects its annual profits to meet consensus market expectations of £632 million, although it has warned of a fall in the first half.

Brokers seem confident. Shore Capital has upgraded its investment rating to hold from sell and Barclays Capital has gone from equal weight to overweight, while both Deutsche and UBS has raised their recommendations to buy. UBS has a price target of 240p on the shares.

Before we get half-year results from Sainsbury’s on Thursday though, Wm Morrison Supermarkets (MRW) is first up, with a trading update on Tuesday.

And shareholders will no doubt be eagerly awaiting good news after the supermarket chain surged to the top of the FTSE 100 leader board, rallying more than 4.5%, after it said it would pay a special 2 pence a share dividend following a rise in profits in the first-half of the year. The company also increased its interim ordinary dividend by 4.3% to 1.93p a share.

Pre-tax profits were almost 50% higher in the six months to the end of June, while total revenue disappointed, picking up by just 0.4%. But Morrisons put it down to an uneventful summer. 

It said that while last year’s results had been boosted by very favourable summer weather and events such as the World Cup and the royal wedding, this summer’s “largely unfavourable” weather and no events of any note were the reason for the comparatively modest uptick in revenue.

But, looking ahead, the company said it sees meaningful and sustainable growth opportunities ahead, with extensions of its wholesale supply partnerships with Amazon and Rontec, and two new partnerships - with Harvest Energy in the UK, and LuLu in the Middle East.

Morgan Stanley has an equal weight investment rating on the shares, but has cut its price target from 245p to 229p. Deutsche Bank has upgraded its rating to buy, the same as UBS, which has also raised its price target to 250p.

Is Associated British Foods’ (ABF) golden goose at risk of turning into a dying duck? That’s the burning question after a profit warning that Primark, the fast-fashion brand that has propped up the conglomerate’s balance sheet, won’t be delivering the goods next year.

ABF’s shares fell sharply, after it revealed that same-store sales at Primark were expected to fall 2%, amid a tough UK trading environment.

It’s little wonder the news came as a blow; Primark alone generates slightly more than half of ABF’s sales and nearly 60% of operating profits.

In the update, ahead of the close of its financial year, Associated British Foods did confirm though that its previous guidance - that annual adjusted earnings per share would be stable from the 134.9p achieved a year earlier - still stood firm.

ABF is a real mish-mash of companies. As well as Primark, it has a sugar production business, a grocery unit that sells Twining’s tea and the Ovaltine malted drink, and an agriculture and ingredients business. 

For a while now, growth in its retail and foods businesses has continued to offset lower sales in the sugar division, where prices have been falling because of global over supply. With this warning over Primark, shareholders will need reassurance that that will continue.

Berenberg is confident it will. It has just repeated its buy rating, but has cut its price target by a pound to £27. ABF’s shares are currently trading at £22.24.

Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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