Disappointing Sales for Sainsbury's

Supermarket J Sainsbury (SBRY) reported a disappointing trading performance for second-quarter 2017, the 16-week period ended September 24. Same-store sales fell 1.1% excluding fuel, which shows no improvement on previous periods. The weakness in sales was brought about by price cuts, while volumes are growing. The figures contrast with the accelerating sales for rival supermarket Morrison's (MRW), which reported a couple of weeks ago.

The price cuts mark a change in Sainsbury's’ commercial strategy, with the firm moving away from promotions towards an everyday low price strategy. In our experience, this is a good thing, as it usually helps improve a store's price perception among customers and reduces complexity in the supply chain and logistics. The decrease in promotions was also linked to Sainsbury's’ attempts to help customers eliminate food waste by ending almost all multi-buy promotions in stores.

The figures also show strong shifts from customers shopping in store to online retail, which reported good sales growth of 8%, and a strong performance from convenience stores, which increased sales by 7%. Clothing sales were weak, owing to a poor market and a strong basis of comparison from the previous year's quarter.

Sainsbury’s completed the purchase of Home Retail Group on September 2. It is still early days, and it remains to be seen what impact this might have in strengthening the online offer and enabling Sainsbury’s to capture a larger share of the significant non-food market. Sainsbury’s has been one of the few traditional firms to increase market share over the past few years, and its solid online and convenience store presence should continue to fuel growth. However, the acquisition of Argos could distract management from challenges faced by the grocery business.

Investment Thesis

Sainsbury’s was the leading U.K. grocer until the mid-1990s, but Tesco and garnered scale by building out store concepts and better articulating value propositions, and both of these firms now lead the market alongside Sainsbury’s. We think Sainsbury’s has enough scale to remain reasonably competitive on price, but we don't believe that it possesses a cost advantage relative to other market leaders.

Moreover, switching costs are virtually non-existent in the grocery industry, and it's not clear that Sainsbury's points of differentiation are strong enough to ensure that excess returns on capital can be sustained over the long term. As such, we do not assign Sainsbury an economic moat.