The Hidden Nasty In J Sainsbury plc’s Latest Results


J Sainsbury (LSE: SBRY) (NASDAQOTH: JSAIY.US) has been the darling of the supermarket sector for some years, thanks to an impressive run of 36 quarters of unbroken sales growth.

The firm’s outgoing chief executive, Justin King, is rightly respected as the man who had turned Sainsbury’s fortunes around, solving its chronic logistics problems, and growing its market share against tough competition.

Yet there’s one problem that Mr King never managed to solve — a problem that becomes evident as soon as you look at the firm’s accounts.

Low profit margins

Sainsbury’s has always had lower margins than the other major UK supermarkets — but why?

Let’s compare gross and operating profit margins for the three main London-listed supermarkets. To smooth out short-term fluctuations, I’ve averaged the last two years’ results for each firm:

Supermarket Gross Margin Operating margin
Tesco 7.4% 4.9%
Wm Morrison Supermarkets 6.8% 5.4%
Sainsbury  5.5% 3.86%

Source: Company reports 2012/13

Gross margin is simply the difference between the cost of an item, and the price you sell it for. It ignores other costs, such as administrative and finance costs, and is a useful way of comparing similar retail businesses.

Sainsbury’s two-year average gross margin of 5.5% is 1.9% lower than Tesco’s 7.4% average, and 1.3% lower than Morrisons’ average of 6.8%. I think it’s fair to say that Sainsbury’s prices aren’t lower than those of its two competitors, so the opposite must be true — Sainsbury must pay more for the items it sells than Tesco and Morrisons.

Sainsbury’s operating margin is also substantially lower than those of its peers, as you’d expect, although Sainsbury’s, like Morrisons, does have one advantage over Tesco — the UK supermarkets’ administrative expenses account for 1.9% of their sales, compared to 2.5% for Tesco. Early on in his tenure, Mr King scrapped Sainsbury’s plans to expand overseas, and I suspect that this is the reason that both Sainsbury’s and Morrisons enjoy lower administrative costs than Tesco, whose overseas ventures have been quite costly.

What about the future?

To be fair, Tesco and Morrisons have both reported a fall in profit margins during the first half of the current year, and I expect they will both end the year with lower profit margins than usual.

However, my worry is that unlike its peers, Sainsbury’s already has low margins. A fall in sales, or any pressure on costs, would have a rapid effect, and could ultimately threaten the firm’s dividend.

Is the dividend safe?

Sainsbury's 2014 forecast P/E of 10.6 and prospective yield of 5.0% look cheap. However, this may be because investors are pricing falling sales into Sainsbury's share price.

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> Roland owns shares in Tesco and Wm Morrison Supermarkets but not J Sainsbury. The Motley Fool owns shares in Tesco and has recommended shares in Morrisons.