Are Sainsbury's shares a bargain?

After more than a year in the shadow of arch rivals Tesco and Morrisons, buyers have begun piling back into Sainsbury's. Third-quarter results were much better-than expected, and newly acquired Argos surprised the City with knockout numbers.

Sainsbury's took over £1 billion during a record Christmas week, driving like-for-like retail sales up 0.1% in the 15 weeks to 7 January. While that was well below the 2.9% reported by Morrisons yesterday, analysts had penciled in a fall of 0.8%.

Argos, the catalogue chain which chief executive Mike Coupe paid £1.4 billion for last year, also had a blinder over the festive period, posting like-for-like sales growth of 4%, miles ahead of consensus estimates of 1%.

The takeover has played out well, but Sainsbury's still trades on just under 13 times forecast earningsClearly a hit during the key Black Friday shopping bonanza and pre-Christmas sales, Argos was a major driver of group-wide growth of 1% in the third quarter.

In reaction, Sainsbury's shares shot up as much as 7% Wednesday to 277p, their highest since May last year. And it's obvious now that traders think recent underperformance makes the grocer a bargain.

Since the end of 2015, Sainsbury's shares have lagged peers Tesco and Morrisons by 37% and a staggering 57%, respectively; its bid for Argos-owner Home Retail holding back its recovery early in the year.

The takeover has played out well, but even after its new-found popularity, Sainsbury's still trades on a smidge under 13 times earnings estimates for the year to March 2018, a big discount to Tesco on 15.7 and Morrisons' 18.3.

Clothing was the stand-out winner during the quarter, with sales up 10%, and sales momentum continued in the online groceries business - up 9% - and convenience divisions - up 6% - with record levels of online sales. Granted, these numbers are better than expected, but they still pale in comparison to the wider industry.

However, with no mention on profit, it's clearly comfortable with company-compiled consensus of about £573 million. "Although Argos growth was very strong, the categories in which it has done well (e.g. technology) tend to generate thin margins, so there is not necessarily the same read across for profit," Barclays analyst James Anstead explains.

The backdrop was certainly the most supportive it has been for sales for a long time. Back in food inflation territory, the industry grew 3.4% in December and investors would have to go back to July 2013 to find a better month - ignoring Easter periods.

Transformation period

Eyes will now turn to tomorrow, which is a bumper day for retail results, with big names like Tesco, Marks & Spencer, Debenhams and SuperGroup reporting.

There is lots of uncertainty, but any consumer squeeze will take time to manifest itself.The big supermarkets are going through a heavy transformation period, with focus switching from multi-buy promotions to simple, lower, every-day prices.

There is lots of uncertainty, although any consumer squeeze will take time to manifest itself. Although promotional sales across the industry were at their lowest level for any Christmas since 2009, Sainsbury's shoppers paid 14% less for their typical Christmas basket this festive period compared to two years ago - but this might not last.

Supermarkets are worried that sterling's devaluation since the EU referendum will lead to price increases in 2017. Indeed, it seems inevitable, and Sainsbury's today warned that the market "remains very competitive" and that the impact of the devaluation of sterling "remains uncertain".

With sterling weak and Prime Minister Theresa May set to trigger Article 50, there is lots of uncertainty, although any consumer squeeze will take time to manifest itself.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.