Can the Sainsbury’s share price ever return to 590p?

Does J Sainsbury plc (LON: SBRY) offer recovery potential following the Asda tie-up?

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The Sainsbury’s (LSE: SBRY) share price has enjoyed a resurgence in the last six months. It’s risen 31% in that time, now trading at around 335p. One reason for this is renewed optimism from investors following the deal to purchase Asda. It could mean a competitive advantage versus rivals that could help it to outperform the wider supermarket sector.

However, the stock is still a long way from its all-time high of 590p. This was recorded in 2007 when the prospects for the UK economy were relatively bright and the company was the subject of potential bid approaches. Looking ahead, could it return to those highs over the medium term?

Mixed outlook

The prospects for the UK supermarket sector remain exceptionally challenging. Consumer confidence has been weak for a number of months and is expected to remain so over the near term. Brexit seems to be having a negative impact on spending habits in the UK. Although wage growth has now edged higher than inflation, this means that disposable incomes are growing in real terms. However, consumer confidence remains relatively weak.

Looking ahead, this situation could continue over the medium term. This could hurt Sainsbury’s growth prospects, with budget retailers such as Lidl and Aldi likely to enjoy further growth in such a scenario.

However, the Sainsbury’s/Asda merger could provide the enlarged business with a competitive advantage in terms of costs versus rivals. At a time when consumers are increasingly price conscious, this may help to support higher margins for the business versus peers. It could help to stimulate profit growth, with the market expecting growth in earnings of 6% in the next financial year.

Further profit growth could be ahead, while a forward dividend yield of 3.5% suggests that continued share price growth could be delivered. A share price of 590p seems unlikely in the medium term, but Sainsbury’s could outperform the FTSE 100 despite Brexit risks over the next few years.

Challenging outlook

While Sainsbury’s seems to offer investment potential, retail sector peer Game Digital (LSE: GMD) could experience a challenging outlook. The company reported a year-end trading update on Tuesday which showed that its gross transaction value increased by 1.8% in the year to 28 July. Its UK performance was disappointing, with a 1% fall in gross transaction value, while 7% growth in Spain helped to offset this.

Looking ahead, cost savings could help to improve the financial performance of the business. Its collaboration agreement with Sports Direct on the BELONG experienced-based gaming activity could act as a catalyst on its future performance, with growth acceleration planned in the current financial year.

Despite this, Game Digital is expected to remain loss-making in the 2019 financial year. It continues to face a difficult market environment, and this could lead to a decline in investor sentiment. With the company appearing to lack a competitive advantage versus peers, it seems to be a stock to avoid at the present time.

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Peter Stephens owns shares of Sainsbury (J). The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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