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Shares worth keeping in your basket

The Times

Supermarkets are already balancing higher wage, freight and energy costs with keeping up with the competition, but Argos greases the tightrope for J Sainsbury. Owning the former catalogue retailer makes Sainsbury’s more vulnerable to a decline in discretionary spending than big rivals such as Tesco or Asda.

Sales at Argos fell by just over 10 per cent during the first quarter of this year and were almost 5 per cent behind the pre-pandemic level, even if the rate of decline eased during the latter 11 weeks. Underlying pre-tax profits are still expected to come in at between £630 million and £690 million this year, down from £730 million last year when sales were amplified during lockdown.

Knowing where demand lands for non-food goods later this year, particularly when the energy price cap increases again, is one of the big uncertainties for which part of the guidance range profits will be in this year, or indeed whether the supermarket misses altogether.

The market has priced in that extra risk. An enterprise value of just under five times forecast earnings before tax and other charges this year is a reduction on a multiple of almost six at which Sainsbury’s was valued at the start of the year. During that time shares in the FTSE 100 constituent have fallen by almost a quarter.

Keeping prices competitive is the big challenge for supermarkets, lest they repeat the blunder made after the 2008 financial crisis, when passing on too much cost inflation to customers via higher prices led to the German discount retailers Aldi and Lidl stealing market share. Discounters have already stolen a march since the start of this year, according to data from the market researcher Kantar. Aldi and Lidl gained market share over the 12 weeks to the middle of June, compared with the 12 weeks to the end of January, while each of the big four supermarkets have lost share.

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The decline in grocery sales at Sainsbury’s during the first quarter was less severe than analysts had expected, down 2.7 per cent against last year, but still 8.7 per cent ahead of pre-pandemic levels. Savings derived from cost-cutting, including reducing the standalone Argos store estate and integrating the Argos, Habitat and supermarket logistics and supply chain networks, have helped fund investment in prices.

There are signs that customers are trading down to economy, own-brand ranges, sales of which grew by the mid-to high single digits during the quarter. The rate of price inflation for the average basket was also lower than like-for-like product inflation, according to the outgoing finance chief, Kevin O’Byrne, which could indicate that shoppers are switching to cheaper ranges.

A worse or prolonged shrinkage in sales — grocery or otherwise — would force the supermarket to work harder to hit a key cost reduction target. It aims to cut general and administrative costs as a proportion of retail sales by 2 percentage points by 2024, versus the 2020 ratio.

Free cashflow generated by the business has improved, thanks to better profitability at the core grocery business and at Argos, where costs have been cut. That means leverage has been brought down faster than expected. More generous cash returns by Tesco, which launched a £750 million share buyback this week, is one reason the stock trades at a premium to Sainsbury’s. But a stronger balance sheet means special returns could materialise in the coming years, reckon analysts at Shore Capital. The brokerage forecasts a dividend of 12.6p a share, which would represent a potential yield of 6 per cent at the current share price. With Sainsbury’s priced for a fall, that should be enough to compensate remaining shareholders.

ADVICE Hold
WHY The shares are worth holding for a generous dividend, which looks secure enough

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IntegraFin
As post-pandemic falls from grace go, the one recorded by the investment platform provider IntegraFin has been more brutal than those suffered by mainstream rivals such as Hargreaves Lansdown and AJ Bell. Shares in the FTSE 250 constituent have halved in value since the start of this year to leave them priced at 13 times forward earnings, compared with a multiple of around 30.

The trading company has hardly endeared itself to investors. First, there was an aborted attempt to take over rival Nucleus, which faced opposition from staff at the target company. Next, the announcement of an increase in labour costs over the next two years as the group takes on a 50 new software development and systems staff. News of a potential VAT bill of £10 million running back to 2016 and the possibility of an ongoing charge also sent the shares lower. No provision has yet been made for that prospective tax bill and the decision is being appealed.

It is the second in that list of red flags that has had the most chilling effect on earnings expectations. Brokerage Shore Capital cut earnings forecasts for this year and the next by 11 per cent and 14 per cent respectively. Higher costs are not the only reason earnings are expected to fall this year: negative markets could well reduce the level of funds under direction, causing revenue to fall. Investment platforms typically benefit from a level of operational gearing, which means that any decline in revenue could be even more painful to the bottom line.

Yet the underperformance of Hargreaves and AJ Bell is not entirely logical. Unlike those better-known names, retail investors cannot sign up to use IntegraFin’s platform directly; instead the platform secures new business via advisers using it to manage their clients’ money. Unlike direct-to-consumer firms, IntegraFin did not see a rise in inflows of the same magnitude in the pandemic — but neither did it endure the same level of decline in the rate of new business. During the three months to the end of March it recorded net inflows of £1.4 billion, only a slight reduction on the same time last year.

The path out of the current market volatility could be a smoother one.

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ADVICE Hold
WHY The shares are cheap enough to account for the likely fall in earnings this year

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