In early 2020 defensive stocks really proved their worth as Covid-19 fear overwhelmed financial markets. The ADR of UK supermarket group J Sainsbury plc (OTCQX:JSAIY), known locally as Sainsbury’s, was trading at $10/share at the end of February, at the end of March it was still trading at around $10/share, while stock market averages were down sharply and many stocks had been crushed. Then, all through the summer, as market averages recovered, albeit with individual stock performance being widely differentiated depending on the pandemic’s effects, Sainsbury’s ADR still held steady at around $10/share. In recent weeks as positive news flow hit the newswires with respect to the vaccine, Sainsbury’s rallied to $12/share. On the 2nd of December, newspapers reported that the UK regulator had approved the first vaccine and the UK population breathed a collective sigh of relief that the light at the end of the Covid-19 tunnel was getting very much brighter.
You would think this would be positive for Sainsbury’s as a vaccine would be the first step towards a UK economic recovery. Lockdowns would be close to a thing of the past and consumer’s savings and pent up demand would burst out in all forms of spending, helping retailers of all kinds.
So, I was a bit surprised when I recently saw Sainsbury’s investor relations give a webinar to private investors to discuss the group’s half year results and strategy. You might think this is a good thing, and in a way it is. But it is an extremely rare thing for a FTSE 100 company to give a webinar directly aimed at retail investors.
I thought something must be up, so I decided to look at the level of short interest in J Sainsbury recorded by UK financial regulator the Financial Conduct Authority. The data is good because it records all short positions of any investor summing to more than 0.5% of a stock’s share capital. This means only big investors are covered. The results shocked me: disclosed short interest was 7.9%, up from just 3.6% at the end of 2019. This level of shorting is one of the highest for any stock listed on the London Stock Exchange. Not only that, but the short interest included some of the most sophisticated hedge funds around: BlackRock, Citadel, Marshall Wace, and Third Point are all short more than 0.5% of Sainsbury’s share capital. No wonder the Sainsbury’s investor relations team was working overtime.
I was intrigued. The Sainsbury stock doesn’t look particularly expensive, and its position as a value oriented supermarket should put it in a good position as the UK economy struggles with high unemployment and sluggish economic growth. As I investigated a bit more, I began to understand why Sainsbury’s is being shorted by the smart money.
Even besides the fact that my own lockdown experience left me frustrated with Sainsbury’s as I struggled to get groceries delivered to my home from them, as I sought, like millions of others at the same time, to avoid public places. After trying many times, I was unable to book a slot with Sainsbury’s as they seemingly failed to ramp up their logistical operations to cope with the huge surge in delivery orders. Rival Tesco on the other hand was able to ramp up so I switched my orders there. As my priority was just getting groceries delivered, I was not bothered about which supermarket they came from. In the end, wherever I could find a delivery slot, with Tesco, Ocado, or Waitrose, I was happy to make the order. Sainsbury’s had frustrated me with their constantly unavailable delivery schedules, so I gave up trying with them. A missed opportunity for them to grab millions of new and grateful customers.
While this anecdotal story can’t be the basis for shorting a stock, it did shine a light on Sainsbury’s performance for me compared to main its rival Tesco, who on the whole impressed me a lot with their Covid-19 crisis management era operations.
A deeper look
It’s with this backdrop that Sainsbury’s relatively new boss Simon Roberts, finds himself in now, indeed a very unenviable situation. It wasn’t looking so bad when his appointment was announced at the beginning of the year but obviously a lot has changed since, as shown by the rise in the short interest.
Before the lockdown era which started in March, Sainsbury’s strategic progress had been better than many had assumed it would be following a damaging and expensive failed merger with Asda a year and a half ago. The collapse of the merger left Sainsbury’s looking both overindebted and with an outdated corporate strategy. However, trading had started to benefit from a increased focus on ‘value’ and property sales had helped bring down debt levels a bit.
Everything changed with the coronavirus pandemic. The stock price initially outperformed as everyone could see the surge in volume as the UK populace rushed to panic buy everything “en masse” which left supermarket shelves empty by lunchtime for several weeks. But this increase in volume wasn’t going to automatically increase profits. On the contrary, costs shot up more than commensurately and simultaneous to the surge in demand, forcing margins down. Then as lockdowns started discretionary non-food sales were hit as in certain regions non-food sales were not allowed under new government lockdown rules. As the economy tanked Sainsbury’s would see major losses in its bank division as borrowers struggled to repay loans.
Sainsbury’s runs more than 1,400 supermarkets and convenience stores across the UK, owns a bank and an electronics retailer called Argos. Groceries account for about 66% of sales, and almost 20% of all sales came from online in the year to March. This online figure surprised me given Sainsbury’s inability to meet my own online demands during lockdown.
In Q1 Sainsbury’s retail demand surged thanks to lockdown, with first quarter like-for-like sales up 8.2%, but the increased activity was offset by at least £500m of pandemic-related costs. The pandemic also forced the group to delay store investment, and this will probably negatively affect future performance. The growth in grocery demand was indeed led by online sales more than doubling, although this business is less profitable as Sainsbury’s clearly lags Tesco and Ocado in delivery logistics. So the trend towards less profitable online sales which seems set to persist for a long time is a major problem for Sainsbury’s and will dilute its already thin margins. Further capex will need to be invested in in technology and distribution to improve its online delivery offering.
At the same time, discounters such as Aldi and Lidl have been steadily eating Sainsbury’s “value” lunch, as the two German businesses go from strength to strength offering no-nonsense, no frills, high value for money groceries shopping experience across the UK. The competition is demonstrated by the fact that over the last five years, Sainsbury’s market share in UK groceries has gradually dropped from about 17% at its peak to below 15% based on market research firm Kantar’s data.
As shoppers struggle with the economic damage caused by the pandemic, Sainsbury’s position at the more expensive end of the “value for money” supermarket spectrum could mean it loses more customers to rivals offering better value. Its large geographic store footprint advantage is also being eroded by the growth of online deliveries.
Sainsbury’s relatively high proportion of discretionary non-food sales which account for 27% of turnover, increased by its acquisition of Argos four years ago, has also made it very vulnerable to both the economic downturn and to the lockdowns that have shut non-essential stores. While the vaccine is in sight, it’s going to take a long time for everyone to be administered it and for the new social distancing habit to be kicked, which potentially could impact them for a long time.
Sainsbury’s struggling banking business will probably also face big losses in the current recession. Even before the pandemic Sainsbury’s logic in owning a bank was questionable, as it has been bleeding money over the last couple of years, needing injections of £35m in 2019 and £110m in 2018. The Global Investor thinks maybe £300m to £400m might be needed by the bank in the next 2-3 years as non-performing loans appear more frequently in the loan book.
To its credit, Sainsbury’s Bank quit the mortgage business last year and has tried to rein in loans so far this year. But for a loyal Sainsbury’s customer struggling financially, being turned down by Sainsbury’s Bank is certainly going to dent that loyalty and drive more customers to discounters. While this conservatism might stem banking losses in the short-term, as a long-term strategy it damages the bank’s brand and size. All this adds to the impact on the bank from the low interest rate environment and flat yield curve. Sainsbury’s would be better off just exiting banking altogether and simply partnering with a bank or credit card provider on branded cards, providing customers with some benefits while ridding itself of the financial and operational risks of being involved in financial services.
The Balance Sheet
Sainsbury’s balance sheet is stretched. Net debt at the end of the 2019 financial year stood at £6.9 billion, which includes £5.8 billion of lease liabilities. While this is down from £7.3 billion in the 2018 financial year, aided by £143m from store disposals by a property joint venture, it still represents more than 3x EBITDA.
Unfortunately, Sainsbury’s has a bit of a track record in announcing large exceptional items and with the pandemic causing havoc to earnings and the balance sheet it would be no surprise if the new CEO “kitchen-sinks” a whole swatch of writedowns in his first year to wipe the slate clean for the rest of his tenure, a trick employed by many new CEOs.
This all leads me to the conclusion that Sainsbury’s is not actually a defensive stock. The price action in the stock in the early part of this year was based more on perception than reality which could be forgiven based on the chaos in the markets at the time. Sainsbury’s could very much do with an equity raising to shore up its balance sheet and fund a new set of restructuring writedowns and online delivery investments which are badly needed.
While some investors may naively see some value in Sainsbury’s forward P/E ratio of around 11x, and feel the stock is still a low risk defensive play in a still uncertain period for the UK economy, The Global Investor predicts there will be no real growth in earning per share for several years and the stock is more risky, given its high debt and probable need for more equity, than it is widely perceived to be by a large proportion of ordinary investors. In short it is a value trap, and the private investor webinar doesn’t indicate much. The short interest is the real indicator.
Follow the smart money which is shorting the stock. Sorry Sainsbury’s, it’s a Sell.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in JSAIY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.