J Sainsbury (OTCQX:JSAIY) is a favorable risk/reward investment. Priced at a reasonable EV/EBITDAR multiple of 6.08 (TTM ending 3/22/08), with operations transitioning from turnaround to growth and a property value backstop of well over the market cap. J Sainsbury provides little downside with significant upside potential.
Operations have improved under chief executive Justin King. Sainsbury’s three year plan (beginning in 2005) to increase sales $5 billion has just been successfully completed. J Sainsbury is planning to invest $4.9 billon over the next three years with the goal of increasing sales another $6.8 billion (2010). Year-over-year sales growth is 6% with 4.5% in same-store-sales increase. This is evidence of a sales led turnaround.
However, the key interest in Sainsbury’s stock is its property assets. Highlighted by Sainbury’s South-East properties, the estimated valuation is between $17.8 billion and $19.1 billion. The current market cap is $12.7 billion. LTD $4.2 billion with $1.6 billion in cash making an EV of $15.2 billion.
Recapitalization of JSAIY is distinct option. Using a sale and leaseback vehicle as a financial exit would realize its property values.
Sainsbury gathers additional upside potential as a target. J Sainsbury has had two failed takeover attempts in 2007. Private equity CVC consortium offered $21.7 billion (excluding debt) in April 2007 and Delta (Two) offered $24 billion in November 2007. There are a number of other interested parties in the company.
In summary, JSAIY is a value priced turnaround/growth story with a real estate backstop (recapitalization with sale leaseback) and a potential target.
Note: The currency exchange GBP = USD has adjusted over the past years. In this analysis all values are converted at a 1.97 exchange rate.
J Sainsbury Plc
Sainsbury is primarily a UK based grocer and related retailer. JSAIY has two operating divisions; 1) about 480 supermarkets, 290 convenience stores totaling 17.6 million square feet, and 2) financial services (Sainsbury Bank). About 114 stores provide internet-based home shopping service. Its non-food offerings are approximately 15% of sales (compared to an industry leading 24% by Tesco).
JSAIY’s 3-year strategy is to increase sales $6.8 billion with 2/3 coming from grocery and 1/3 from non-food. Sainsbury’s sales have increased $4.9 billion in the past 3 years. They plan to grow store space by 10%, and add another 200 online stores along with 100 new convenience stores. Sainsbury is in transition from turnaround to growth. The operating margin still lags behind its major competitors. TTM EBIT margin is 3.0% compared to industry leader Tesco EBIT margin of 6.0%. Margins are depressed about 1% because of previous management’s over investment in IT, and another 1% because of their comparative high rental space. JSAIY rents about 40% of their retail space compared with 30% at Tesco and about 10% at Morrisons.
Sainsbury, under King, is fixing the basics; adopting a customer-focused culture, refurbishing stores and broadening its product range. A 3-year cap ex of $4.9 billion has been announced by management.
J Sainsbury trades under symbol JSAIY, a 4-1 ADR, and in the pink sheets under JSNSF. JSAIY has the volume to trade. In March - April of 2007 JSAIY traded in the mid $40’s during the takeover attempts. It currently is trading at $27.40. There are 1,760 million shares. Delta (Two) owns 25% (up from 7% from 6/07 likely going to 30%), the Sainsbury family controls 17% (billionaire David Sainsbury holds 7.75%) and Robert Tchenguiz owns 5% (with another 5% in derivatives). Incidentally, Delta (Two) paid and average 595 pence ($46.88 per share) in increasing their holdings in the past six months.
UK Supermarket Industry
The UK supermarket industry is very concentrated. The top 4 competitors make up 75% of the retail market. Tesco Plc leads with a market share of 31%; Asda, a subsidiary of Wal-Mart, 16.7%, Sainsbury 16.3% and WM Morrison 11.2%. Consumers are trading upwards to healthier foods in premium categories, and supermarkets are beginning to extend beyond their non-food boundaries.
In May, Sainsbury reported that recent pressure on consumer spending and continuing competition shows no sign of easing. This underscores the current macro conditions in the UK.
Operating Valuation Comparisons
Failed Takeover Attempts
CVC Capital Partners, The Blackstone Group, TPG Capital, and KKR made a bid of 582 pence for Sainsbury in April of 2007 - $21.7 billion ($45.86 share). The offer was effectively blocked by the Sainsbury family. A 75% approval rate was a technical factor in the takeover attempt. The economics of the offer were also changed by the pension trustees who wanted $5.9 billion to “top-up” the $880 million accounting pension deficit, claiming the investment return assumptions were outdated. Goldman Sachs, RBS, and Barclays Capital initially agreed to back the LBO.
In November, Delta (Two), a Qatari backed 25% shareholder, offered $24 billion (600 pence -- $47.28 per share). Paul Taylor, manager of Three Delta, the investment advisor of Delta (Two), was forced to walk away from its proposed takeover after funding costs soared, and embarrassingly they could not raise additional equity from their partners. The pension plan also became an issue. Taylor, in response to Delta’s failed bid and increased holdings said: “we are . . . focused on long-term, exceptional businesses . . . with strong management teams, leading market positions and long term growth opportunities.” Delta is eligible to make another bid under UK law after 6 months (May 2008).
Other Interested Parties
Retailer Marks & Spencer chief executive Stuart Rose admitted considering a bid in the $20 billion range if another offer was made. Sainsbury’s chairman Philip Hampton was warm to this idea as he did not want to be vilified for ‘selling on the cheap’ to private equity.
Asda, Britain’s number two grocer has taken advice on an offer but is reluctant to act because of the competitive issues with the government. Apax, a private equity firm that owns rival grocery chain Somerfield ruled out a bid for the same reason.
It is reported that buyout firms Bain Capital and Apollo were considering a bid.
Property magnet and 5% shareholder of Sainsbury, Robert Tchenguiz has been an activist and is increasing his stake in the company. Tchenguiz was quoted as saying Sainsbury was “a real estate business with a retail business on the side.” Tchenguiz has suggested the company use a sale-leaseback approach to increase shareholder value. In 2007 before the commercial market began to slide, JSAIY could be worth between 600 pence ($47.28 a share) and 700 pence ($55.16 per share) using a sale-leaseback structure.
Previously, J Stainsbury said its freehold property was worth $14 billion. This has been raised by JSAIY to $17.2 billion on an ‘investment basis valuation’, but still short of the 2007 speculated $19.8 billion. World renowned property consultant DTZ places the value at $17.8 billion. In March 2008, JSAIY purchased 38 stores from British Land which was under a sale/leaseback. 25 of the stores are scheduled for expansion. King stated that the $538 million deal would strengthen the property value of these assets.
Commercial retail property in the UK is decreasing in value. Access to credit is difficult. Leases vary widely. However, properties in the UK and particularly in London attract international investors and are in high demand. 25% of commercial ownership is foreign held. Office space in London and other major cities in the UK are holding their own in a difficult market. CFO Darren Shapland said in May, 2008 the real estate is worth between $15.76 billion and $16.9 billion. I am using a property value of $15.36 billion for estimation. Sainsbury’s property value loss in the 2008 market slide is roughly $5 billion. This is an after tax ADR value of $7.38 per share.
Cap rates for British property are very low – 4.5% to 5.5% and edging up slightly. U.S. grocery stores cap rate is in the low 6’s to low 7’s. With the anticipated slowing in cash flow growth rates, a UK grocery cap rate of 6% is reasonable
Unlocking Property Value
Sale and Leaseback
Unlocking property value through sale and leaseback relies on the credit quality of the tenant and the rent, with the key question being the rent. The property value is a function of that rent, thus the range on valuation. Robert Tchenguiz prefers this as a financial exit. Sainsbury carries a BBB- investment grade rating from S & P along with a BBB- on the CMBS.
Post Sale/Leaseback EBITDAR
EBITDAR will not change with the recapitalization. $2.5 b EBITDAR at a conservative multiple of 4 (current multiple is 6.08) gives a market cap (EV, as there is no debt post sale/leaseback - excluding cash) of $10 billion. $25.57 is the ADR share equivalent.
Commercial Mortgage Backed Securities
CMBS is another alternative to unlocking the property value. By accessing the bond market, Sainsbury could retain ownership and structure the debt similar to the 2006 CMBS albeit at a higher rate on the fixed (see comments in next section). JSAIY in March of 2006 transacted $4.2 billion of CMBS against 127 of the supermarket's properties. This is about half of its property portfolio (by space).
Real Estate Investment Trusts
The least likely alternative is the UK REIT. Regulations require that the tax-free status for REITs can not have a single owner for more that 10%. Delta (Two) and the Sainsbury family are unlikely to give up control to obtain the REIT status.
Traditional LBO Estimate
Using conservative EBITDA growth estimates and the same exit multiple, Sainsbury does not qualify for a traditional LBO candidate. The asking price is far above the common 25% - 30% stock price premium. The private equity and minority shareholder interest in the value of JSAIY is clearly in the real estate.
Current UK Commercial Real Estate Market
Since mid 2007 the commercial real estate market in the UK has declined. Prices have declined in the fourth quarter of 2007 9.2% and in the first quarter of 2008 another 3.2%. Similar to the U.S. market, underwriting has tightened significantly. JSAIY is in a good position to weather the times as its $4.2 billion CMBS is split with limited amortization over medium-term. $2.4 billion is a 12 year floating rate with final payment due in July of 2018 and $1.8 billion of 25-year fixed rate due in July of 2031.
Food prices have increased 8% over the past 2 years. Soaring grain prices and energy costs have forced retailers to pass its costs on to consumers. JSAIY as part its growth plan, is passing on productivity savings and better expense controls to its customers.
Pricing and Competition
UK's Grocer 33 Index, which publishes a price survey on a basket of items, shows that Sainsbury is the most expensive grocer of the top 4. JSAIY is caught between absorbing inflationary costs and keeping prices in line with its competitors.
Sainsbury is improving sales and operations but so is Morrisons. At Morrisons, Christmas sales were up and year-over-year market share has gone from 11% to 11.4%. Morrisons' has a very successful advertising campaign that makes an already crowded market even more competitive. Asda is using the early Walmart strategy of targeting small communities but the CC ruling (see below) may well hamper their efforts.
Cap Ex and Working Capital
Sainsbury plans include capital investments which include $4.9 billion for the next 3 years. Cash flow is likely to be neutral in 2008. The $800 million revolver has about $400 million uncommitted. Cash is $1.6 billion.
JSAIY has maximized its working capital efficiencies. Finding further supply chain efficiency gains is going to be difficult. Much of the savings will be offset by investments in price and quality to keep competitive.
UK Competition Commission [CC]
In May of 2006, the Office of Fair Trading [OFT] placed an inquiry with the CC about the competition in the UK grocery industry. The 2 year investigation identified a significant number of local areas where larger grocery stores face limited competition. The competition test prevents any one grocer from having more than 60% of the sales within a 10-minute drive. Tesco Plc and Asda will likely be affected most by the ruling. Other recommendations were included in the report but are rather benign.
J Sainsbury's low share price is a reflection of the macro economic concerns in the UK. Operations are on firm footings and the inelastic demand for grocery products bodes well in economic tough times. Clearly the property values exceed the enterprise value of Sainsbury. My conservative estimation is $20.36 share for the property assets on a sale/leaseback strategy. On a post sale/leaseback the operating company on an EPS estimate is $26.88 per share. And $25.57 using an EBITDAR estimate. This makes a good case for today's share price of $25.80 being undervalued. With so much previous attention on Sainsbury as a target, there is a likelihood of renewed interest and thus is a strong potential takeover candidate.
Disclosure: Author holds a long position in JSAIY.PK