In late May, I argued that the shares of Sainsbury’s (LSE: SBRY) should have been considered only if they had plunged to 285p. Back then, they traded at 344p. Now, they change hands at 309p. Sainsbury’s stock may soon deserve a serious look, in my opinion. There’s something you should know about Morrisons (LSE: MRW), too…
Sainsbury’s: In Bad Shape
The shares of the third largest food retailer in the UK are unlikely to rally any time soon, but the good news is that they are getting closer to fair value. That’s become apparent in recent weeks. Sainsbury’s shares trade at a low forward multiple of 5.8x adjusted operating cash flow, while their forward price to earnings ratio is about 11x. The shares of Sainsbury’s may seem properly priced — but are they? Well, I expect a further 10% downside to the end of the year.
Enter estimates for the next three years. The operating income of Sainsbury’s is expected to flat-line, while dividends and earnings growth is very unlikely to impress investors. Sainsbury’s is expected to cut its debt position by about £600m to £1.7bn over the period, which is a good thing, of course, although leverage isn’t problematic – growth prospects are. Sainsbury’s is expected to generate only £1.5bn of additional revenues by the end of 2017, which should add to its current revenue base of about £24bn. The bad news is that such a dreadful outcome could turn out to be a best-case scenario if like-for-like sales continue to drop.
The problem is that Sainsbury’s, as opposed to Morrisons, is an unlikely takeover target. Moreover, market leader Tesco is more troubled, and as such, it’s a more appealing restructuring proposition than Sainsbury’s.
Morrisons: In Terrible Shape?
Based on trading multiples for 2015, the shares of Morrisons – which are down more than 30% year-to-date — are more expensive than those of Sainsbury’s, but looking at trading multiples to value these retailers isn’t very helpful at this point in the business cycle.
More pressure on profits and margins is likely to persist, so neither Morrisons nor Sainsbury’s are appealing — with the big difference that if confidence in the food retail space makes a comeback, Morrisons shares will shine, in my opinion. Why? Because Morrisons may be taken over.
The retailer’s operational and financial hurdles could be a blessing for shareholders if they help speed up a change of ownership, I said on 8 May. The shares are down more than 10% since. More weakness would certainly be a blessing for shareholders now — because the cheaper the shares become, the more likely a takeover will be. Otherwise, there’s no other reason why either opportunistic or value investors should consider an investment in Morrisons right now.
