Sainsbury's profit keeps shrinking

Agreeing to stump up £1.4 billion for struggling catalogue chain Argos was a massive shock, so few expected any huge surprises in full-year results from Sainsbury's. There weren't, and profit actually squeezed past City forecasts. However, the grocer made less money than the previous 12 months for the second year in a row. And admitting that things ain't gonna get better any time soon has slammed a recovery rally into a sharp reverse.

Leaving Argos out of it - the deal is expected to complete in the third quarter - Sainsbury's swung back to a reported profit of £548 million from a £72 million loss last year, when it took a £628 million charge for impairments and onerous contracts on unwanted sites. Strip out one-offs and profit fell 14% to £587 million, better than the £574 million pencilled in by Deutsche Bank analyst Niamh Mcsherry. A year ago, profit fell by 15% from £798 million.

Boss Mike Coupe pointed the finger squarely at the ongoing price war with rivals Tesco, Asda, Morrisons and aggressive discounters Lidl and Aldi. Sales excluding VAT were a little light at £23.5 billion, and retail underlying operating margin fell by 33 basis points to 2.74%.

"The market is competitive, and it will remain so for the foreseeable future," warned Coupe.

It's little wonder Sainsbury's shares sank almost 6% Wednesday. After plunging close to 13-year lows again in January, they rocketed 30% back to 2014 levels last month. With nothing in these results for bulls to latch onto, a sell-off was inevitable.

"While several pressures remain on the UK grocery sector, we believe Sainsbury's promotional strategy can support a relatively better margin performance and we believe the proposed acquisition of Argos can drive significant earnings accretion in outer years," says Mcsherry.

She reckoned the fall was already overdone prior to the numbers, arguing that investors are reluctant to factor in earnings accretion from the Argos deal due to execution risk. Too right they are. While Mcsherry thinks Argos can boost Sainsbury's bottom line by 20% in 2018/19, profit there plunged by 36% in the year to February, and this is a massive gamble for Coupe, possibly a career-defining moment.

At 273p, Sainsbury's shares trade on 15.6 times Deutsche's earnings per share estimates of 17.55p for the year to March 2017. It was 22.8p this time.

While the valuation is not necessarily expensive when compared to Morrisons, and especially Tesco's recovery multiple of 28 times, that price war and Argos risk could easily temper further enthusiasm for Sainsbury's shares - at least until the logic for buying Argos becomes clearer.

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