Is J Sainsbury plc Due A Re-Rating?

Sainsbury'sSainsbury’s (LSE: SBRY) has had an unpleasant year. Its share price has almost halved since January and it now sits on a lowly PER of 7.5x.

Its share price has been dragged down alongside Tesco‘s (LSE: TSCO) and Morrisons‘ (LSE: MRW), and it could be argued that negative sentiment regarding the sector as a whole has unfairly hampered Sainsbury’s share price performance.

Yet it could also be argued that the structural headwinds facing UK grocers — think aggressive, well-funded European competition, food price stagnation and protracted price wars — are simply too much for good management alone to make much of a difference over the next year.

The Best Of A Bad Bunch?

Sainsbury’s has arguably been seen as the pick of the UK grocers. It is perceived to have a more upmarket consumer base to its peers, which is better protected from Aldi and Lidl’s current UK market share raid. This sentiment only partially holds up to data.

The latest Kantar Panel findings show that Sainsbury’s share of the market fell by 0.4% to 16.2% during the 12 weeks to 14 September — significantly better than Tesco’s 1.4% slide to 28.8% of the UK market. However Aldi, Lidl, Asda and Waitrose actually grew their market share over the same time-frame, while Morrisons and The Co-operative fell by less. This raises questions concerning the assumption that Sainsbury’s market share is better protected than its rivals.

True, it has a strong presence in the South of England, while the discounters are focusing on northern regions (for now). Management must also be commended for the timely expansion of convenience stores and its online offering, at least by the standards of the industry as a whole. The same can be said of its smart joint venture with Danish discounter Netto, which will see the launch of 15 new Netto stores by the end of 2015.

Rights Issue Rumours

As soon as Morrisons announced its price-cutting strategy in a bid to tempt consumers back from Aldi and Lidl, Sainsbury’s and Tesco had to follow suit. There are consequences to price wars of this nature, however.

Cutting prices often requires a re-basing of earnings forecasts, as consumers initially buy the same amount or even more while actually spending less. The rationale is that word will get out of the supermarket’s low prices and, eventually, more consumers will shop there for the bargains. Increased consumer volume ends up trumping reduced average spend.

This does beg the question of how supermarkets take the painful initial hit to bottom-line profit of such extreme tactics. Morrisons dutifully re-based its earnings targets and warned over expected lower margins, freeing up billions to fund its price cutting campaign. Tesco has slashed its dividend.

As for Sainsbury’s, there have been persistent rumours of a rights issue, but nothing has happened yet. There is more to come here, and it may not be positive. The situation in the UK grocery sector may well be bearish for a while. Although these shares only sit on a PER of 7.5x, earnings visibility has been markedly reduced by competition and price cuts — and as such, they are for now uninvestable.

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Jack Brumby has no position in any shares mentioned. The Motley Fool UK owns shares in Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.