If Morrisons’ valuation is underappreciated enough to spark a bidding war among private equity firms, Sainsbury’s should scream value. The stock market has slapped an enterprise value/adjusted cash profit multiple of just under six on the orange-bannered grocer, a cut price on Morrisons, even before institutions began circling, and Tesco too.
First-quarter trading figures may give management a needed helping hand in forming a defence against any suitors attempting to launch a low-ball takeover. Like-for-like sales excluding fuel were up 1.6 per cent over the 16 weeks to June 26, ahead of management expectations. On a more meaningful two-year basis, that increase equated to 10.3 per cent, not too much of a slowdown on the 12.4 per cent growth posted for the fourth quarter, despite the reopening of pubs, restaurants and non-essential retail providing competition for customer cash.
Management raised underlying pre-tax profit guidance for the 2022 financial year to at least £660 million, up from the £620 million pointed to in April and ahead of an analyst consensus forecast of £630 million just before this latest trading update.
Sainsbury’s susceptibility to a takeover approach is a point that has not been lost on investors. The shares have risen by 7 per cent since the rival Bradford-based grocer confirmed reports of the initial approach by the American private equity firm Clayton, Dubilier and Rice (CD&R) last month.
Just how likely is an approach? There is more to attract suitors to supermarkets beyond the lowly price tags. Like peers, Sainsbury’s is an asset-rich business that has the ability to throw off a lot of cash. Its credibility problem can be pinned on a struggle over more than decade to deliver sales growth and turn a consistently decent profit. Tesco, the market leader, is more advanced in its earnings recovery strategy.
Sainsbury’s also lacks the vertical integration benefits on offer at Morrisons, which has acquired abattoirs, food processing plants, florists, bakeries, egg producers and a potato-packing plant. Sainsbury’s legacy banking operations, which its smaller rival is without, could also complicate the story.
Less potential to mine returns from a sale and leaseback of the shop estate may also mean private equity is more lukewarm in its interest. Sainsbury’s owns the freehold of about 60 per cent of its store estate, compared with Morrisons’ 85 per cent. That said, that real estate portfolio still totalled an alluring £10.1 billion at the end of March, against the group’s market value of £6.1 billion.
Should investors allow their heads to be turned if a takeover bid does emerge? Simon Roberts, the chief executive, is pinning hopes for an “inflection in profit momentum” this year on an extensive cost-cutting programme, including reducing the standalone Argos store estate and integrating the Argos, Habitat and supermarket logistics and supply chain networks. Savings are to be reinvested in lowering food prices and cutting debt further.
But wafer-thin margins mean any curveballs have the potential to deliver a particularly bloody nose. The threat of the discount grocers Aldi and Lidl is, as Shore Capital’s Clive Black notes, the “constant nervous tension of the UK supermarket scene”.
Over the 12 weeks to June 13, Sainsbury’s had given up the market share gains it made since the start of 2020, according to Kantar Worldpanel, the research group. Aldi and Lidl have held steady during that period. The risk is that management ends up chasing its tail and cash savings are continually swallowed by efforts to defend its competitive position. Pushback against a potential bid might take more work than the task faced by Morrisons.
ADVICE Hold
WHY Lower valuation reflects greater recovery challenges
Purplebricks
Overpromising and failing to deliver is up there among the biggest corporate sins in the market’s eyes and investors are yet to forgive Purplebricks. The online estate agency is still being punished for its costly expansion — and subsequent retreat — from the Australian, US and Canadian property markets.
The shares are not only 83 per cent below their record high but 17 per cent lower than their 2015 initial listing price. Even posting its first annual pre-tax profit was not enough to inspire warmer feelings towards the market upstart, with the shares falling more than 4 per cent by the market close.
It’s not only investors that the group needs to curry greater favour with. The non-refundable £999 upfront fee that irked some home sellers will soon come with a money-back guarantee, if a buyer offer within 10 per cent of their property valuation is not found.
Will the incentive sap the revenue stream? Trials in the North West of England saw a 14 per cent increase in instructions, which “far outweighed” any financial impact from the offer, Vic Darvey, chief executive, said.
The estate agency wants to carve a 10 per cent slice of the market in the medium term, up from 4.6 per cent for the 12 months to the end of April. But efforts to more than double market share won’t come cheap and marketing costs will increase this year, before returning to the 2021 level “over the medium term”, Darvey said.
That planned increase in marketing costs is behind a forecast fall of almost 80 per cent in pre-tax profits to only £1.2 million this year, according to house broker Peel Hunt. Analysts there expect a sharp rebound to £7.9 million in 2023.
Controlling marketing and administrative costs has been a long-fought battle for Purplebricks, admittedly one it gained ground on during last year. But a likely post-stamp duty break cooling in the property market could weigh on revenue growth and its ability to compensate for the expense of UK expansion. Purplebricks is yet to convince that it can balance these elements for the duration.
ADVICE Hold
WHY A forward EV/Ebitda multiple of 23 does not offer an attractive entry point to the shares
