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Can the Sainsbury’s share price double your money?

The Sainsbury (LSE: SBRY) share price has rallied from 177p to 213p over the last two months. Even after this 20% gain, could buyers of the stock have prospects of doubling their money? After all, the price is still nowhere near last year’s high of 342p, let alone its pre-recession peak of towards 600p.

Realism

Let me say at the outset, I think there’s no chance the share price will return to its pre-recession levels on any reasonable timescale. Sainsbury’s has about half-a-billion more shares in issue today. As such, a doubling of the price would put the market capitalisation back to its heyday when the ‘Big Four’ supermarkets ruled the roost.

How about a return to last year’s high? This would represent a still-very-decent 60% upside for buyers today.

M&A strategy

I was critical of Sainsbury’s acquisition of Argos a few years ago. It clearly had to do something to stem falling profits and dividend cuts, resulting from an increasingly competitive market and changing shopping habits. But I didn’t think the answer was to ramp up exposure to discretionary consumer spending by acquiring Argos. Tesco‘s and Morrisons‘ moves into wholesale — maintaining the defensive qualities of their businesses — looked a much shrewder idea to me.

Sainsbury’s proposed merger with Asda made more sense but, of course, was kiboshed by the competition regulator earlier this year. With Plan A(sda) having gone up in smoke, what is Sainsbury’s Plan B?

New strategy

My colleague Roland Head has given a good account of Sainsbury’s new strategy. I’d sum it up as: cut costs, tinker with the store estate, and curtail capital injections into the financial services business.

Sainsbury’s bank has immediately stopped new mortgage sales, and I suspect there are plans to grow consumer lending (the acquisition of Argos came with a large debtor book). This would see new business swing away from secured lending (mortgages) to unsecured lending (customer credit).

Ups and downs

I think Sainsbury’s exposure to discretionary consumer spending and unsecured lending makes it less defensive than its rivals. A merger with Asda would have reduced the weighting of its more cyclical businesses, as well as giving it benefits of scale. Such a business would have merited a higher rating, which is why Sainsbury’s share price climbed last year.

As things are, I think the company deserves a lower rating. What’s its current valuation, and do I see upside or downside from this level?

My view

At the time of Sainsbury’s last results, the City consensus forecast for pre-tax profit for the current year was £652m. However, less than two months later (28 June), the analyst consensus page on its corporate website was updated with a pre-tax profit forecast of £632m.

At the time, I suggested keeping an eye on the page through the year, suspecting we may get an object lesson in how struggling companies manage down ‘market expectations’. So far, the page — which also includes earnings and dividend per share forecasts of 21.6p and 10.6p — hasn’t been updated.

However, website ShareCast is showing a current consensus of £596m pre-tax profit, with earnings and dividend per share forecasts of 19.9p and 10.5p. I think the P/E of 10.7 and yield of 4.9% aren’t particularly good value. Furthermore, with forecasts trending downwards, I see downside risk and would avoid the stock at this stage.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. 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.