Investors used to view the UK supermarket sector as defensive. Repeat purchasing of foodstuff staples leads to reliable cash flow for paying steady dividends, went the argument.
So the fundamental requirement for a defensive investment is consistent cash flow. We are not seeing that at J Sainsbury (LSE: SBRY) right now, and the firm is perhaps the slickest and most trusted of all the British supermarket chains.
Cash flow is falling
There’s been a downward trend in the firm’s operating cash flow for some time:
|
Year to March |
2012 |
2013 |
2014 |
|
Net cash from operations (£m) |
1067 |
981 |
939 |
The recent half-year results show the fall continuing, with the firm generating £398m of net cash from its operations for the six months to September 2014. That compares to the £566m Sainsbury’s received in cash the equivalent period in 2013.
That’s grim, and the directors know it. Sainsbury’s is losing its defensive credentials, along with the rest of the London-listed supermarket sector. If a low-margin, high-volume sales business can’t even deliver steady cash flow, what’s the point in taking the risk of investing in it?
What’s the plan?
With the bottom falling out of its business model, Sainsbury’s recently conducted a strategic review. The results sound like the firm is pitching into a fight for survival.
Sainsbury’s reckons the grocery sector is undergoing structural change as customers shop more frequently, using online, convenience and discount channels. The firm expects supermarket like-for-like sales in the sector to be negative for the next few years. That’s a sobering statement. The very sector is set for a period of decline. That investing environment is not ideal.
In response, Sainsbury’s aims to improve quality and reduce prices with its food products, and to balance such lower margin turnover by growing the non-food business with a focus on design-led clothing, cookware, homeware and seasonal products. The firm aims to dedicate more store space to non-food items. There’s also the company’s banking operation, which has opportunity to expand.
What else could they do?
When faced with a broken business model, something has to change. Food retailing as a profit generator seems something of a busted flush — that’s serious if you happen to own a food supermarket chain.
Maybe, from now on, food retailing as a whole is set to be a loss leader, or at least a very low-margin proposition designed to get footfall through the door. The real profits will then likely come from non-food retailing.
That’s a massive change in modus operandi for Sainsbury’s and its peers such as Tesco and Wm Morrison Supermarkets. Non-food retailing is far less defensive than food retailing and prone to the affects of macro-economic cyclicality. On top of that, the non-food retailing space seems set to become very crowded as once strong and vibrant food retailers, such as Sainsbury’s, switch to the sector. Maybe non-food retailing may not prove to be as profitable as the supermarkets hope.
Sainsbury’s shares are well down this year. At 257p per share, the forward P/E rating runs just over 10 for year to March 2016, and there’s a dividend yield of 5%. That might seem like a fair price, but forward earnings continue to fall and the sector is in structural decline.
If we are thinking of a defensive investment, perhaps we should look elsewhere such as the other firms on the London stock market with strong trading franchises that can really drive wealth creation if we buy the shares at sensible prices.
