MARKET COMMENT
Sainsbury: Number Two Will Do

By David Kuo (TMFDragon)
November 20, 2002

Sainsbury (LSE: SBRY) appears to be running out of ideas as to how it can maintain its market share in the UK grocery market. It currently occupies the number two slot but is in danger of losing further ground to the market leader Tesco (LSE: TSCO) and perhaps to Asda, the supermarket owned by Wal-Mart Stores (NYSE: WMT), as well. The recent announcement that Tesco plans to buy T&S Stores (LSE: TSS) puts even more pressure on Sainsbury. It is in danger of lagging Tesco in both the out-of-town market and in the town centre convenience store sector as well.

Today Sainsbury posted underlying profits of £342m for the first half. This represented an 11% increase on last year. The increase in sales was a more sedate 1.5% to £9.2b. Sainsbury's improved operating margin of 3.6% suggests that the many efficiency improvements that it has implemented, such as improvements to its supply chain and better use of information technology, are finally bearing fruit. More progress in terms of efficiency is not impossible given that the company's operating margin still lags Tesco's 4.7%.

A great deal has been made about the pecking order of the supermarkets. That is to say which is number one and which are the number two and three in terms of market share. This is all very interesting but ignores to a large extent the underlying performances of these businesses. It is true that Sainsbury was complacent in the past simply because it was the biggest supermarket in the land. However, today's results demonstrate that the fight back by Sainsbury is well under way. It may never regain its position as the UK's premier grocer but that, if you'll pardon the pun, is of only secondary importance.

Investing is not about relative positions in the league and it doesn't matter too much if you're only number two. At least that's the case in the supermarket sector where there is not a great deal of difference between the relative sizes of the major players.  What is more important is whether the shares of the company in question are appropriately valued. Profits at Sainsbury is expected to grow at 14% a year in the short term and so a valuation of 13 times profits suggest that its shares are probably fairly valued. The projected growth, however, does not fully account for the strategic moves into non-food items, its store reinvigoration programme, and the various improvements made to its supply chain. This, together with the share's 5% dividend yield, suggest the shares may be attractive.