Sainsbury s slip up kills rally despite reassuring review

Sainsbury’s has managed the remarkable feat of snatching a small defeat from the jaws of small victory, by effectively, making an unscheduled forecast cut, bringing a strong rally of its shares to a rapid halt.

Things seemed to be going reasonably well earlier.

Sainsbury’s shares initially raced more than 4% higher at market open.

That was a reaction to a raft of measures the supermarket group unveiled, aimed at stemming falling profits and market share losses, following the root-and-branch review announced last month.

But later, after senior executives started a round of media interviews, the shares rapidly returned to earth, falling as deeply as 6% lower.

CFO “tickles down” the rally

It looks like ‘culpability’ for the change in trading sentiment on the stock can be laid at the feet of Sainsbury’s chief financial officer, John Rogers, who was quoted as saying, analysts might have to “tickle down a bit” full-year profit consensus of £677m.

Obviously the market responded in mechanical fashion to what was essentially a forecast downgrade.

But there also seems to be an aspect of the way the market reacted that has to do with the frivolous turn of phrase and, more importantly, the fact that Sainsbury’s hadn’t attempted to realign market expectations with its own, by updating official guidance.

As we pointed out last night, it looked like the market was having a bout of hypersensitivity about Sainsbury’s stock, following some good gains in recent days.

There was always a risk investors would over-react to any relatively moderate stimulus, like for instance, a small forecast downgrade, albeit one that in hindsight might have been better received had it been delivered more formally, and through the proper channels.

Sainsbury’s still deserves a light pat on the back

Looking more widely, the main news from Sainsbury’s this morning–decisions about actions it will take in response to its strategic review, and interim earnings, still, in our view, warrants a pat on the back, for Sainsbury’s.

Broadly speaking, the review, which Sainsbury’s CEO Mike Coup said would leave “no stone unturned” when he announced it just over a month ago, has not turned up any new negative surprises.

Plus, whilst Sainsbury’s profit before tax and one off items at £375m for the six months to 27th September was down from £400m in the same period last year, it still topped analysts’ expectations of about £350m.

Finally, the interim dividend is being kept the same as for the same period a year ago, 5p per share.

Reality check

Of course though, these are all relative positives.

The UK’s third-largest supermarket, just like its major peers, remains engaged in a battle against both discounter upstarts that are disrupting decades of dominance by the UK’s major established grocers, and its own overly entrenched business model, that has left it out of step with how most people shop nowadays.

On that basis, Sainsbury’s strategic review was always going to recommend painful measures.

One of the most significant is the change of the dividend policy.

Dividend let down will be gentle

The dividend ratio has been re-calibrated to the new realities of the grocery business.

That means it’s being raised from a minimum of 1.5 times underlying earnings to 2 times.

In effect, the minimum threshold of cash attributable to shareholders has been raised—that has a knock on effect on the amount of cash that can be allocated to dividends.

In practice, we still see the effective ratio for the current year somewhere below, but not sharply, the same level as the prior policy—1.5x.

This revised official policy gives management scope to be thriftier in future.

Further bad news

• ‘Charges including an impairment and onerous contract charges of £628m’—this will probably dent reportable earnings for this year
• Supermarket like-for-likes seen negative for next few years, not much surprise there
• Loss before tax of £290m, albeit narrower than the year before
• Underlying full-year basic EPS, expected down 12.7% to 14.5p (vs. 16.6p in 2013/14)—this looks slightly weaker than expected

Tough medicine that played well

• Continued efforts to grow non-food business, with some interesting sounding design-led ideas, including for home ware
• 250,000-350,000 store openings rate for the next few years—that is a cut, as widely desired by investors, from around 700,000 planned for the current year
• Increased operating cost savings annually will be £150m-£175m
• Continued ‘investment in price’ (AKA food price cuts)—an additional £150m—with half falling in the second half of 2014/15. This seems modest compared to some forecasts

Better than feared, the best on offer

In summary, this review and update could be regarded as about as confident and uncontroversial as Sainsbury’s, and of course, its relatively new CEO, Mike Coup, could have achieved, under the circumstances.

All the sensible things which the market required for reassurance are here, including an even-handed reduction of the dividend policy, planned savings that verge on the aggressive side, and by dint of their absence, no sign of any real catastrophes of the like seen elsewhere in the sector.

Investors might have been expected to applaud this release, in the same way a number of other updates from elsewhere in the sector were welcomed last week.

Unfortunately, Sainsbury’s management made some missteps with presentation, and an edgy market took the opportunity to take profits, after the best six weeks for supermarket shares in six years.

Snatching a small defeat

The stock’s half hourly chart shows the day’s advance and subsequent CFO-fuelled decline, and reveals the immediate task for bulls as keeping the stock above the 100-period moving average which it’s currently flirting with.

Prospects for stemming the losses at current levels don’t look brilliant.

Momentum is in the process of turning more emphatically negative, judging by the Moving Average Convergence Divergence system.

Still, the stock does seem close to rather clear pivot points that may serve as support.

And a return to major support around 223p on the daily chart does not seem to have good odds, at the moment.