Jeremy Warner's Outlook: A bleak future for Sainsbury's as cull continues

Shock ERM therapy; BT break-up
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The Independent Online

With the benefit of hindsight, it wasn't exactly a great career move for Roger Matthews when he quit as finance director of Compass five years ago to take up the same position at J Sainsbury.

With the benefit of hindsight, it wasn't exactly a great career move for Roger Matthews when he quit as finance director of Compass five years ago to take up the same position at J Sainsbury. Even then, the supermarkets group that used to be synonymous with quality was being described as "struggling". Its situation has gone from bad to worse, and with the arrival as chairman of Philip Hampton, the City's favourite finance director, with a brief to clear out the old and bring in the new, Mr Matthews must have known his number was up.

Sainsbury's finds itself in a truly awful position, unable to outperform rivals on either price, product range or quality, and with even the house broker, UBS, slashing its forecast of profits for this year by a fifth to £330m, the shares would plainly be in much worse shape than they already are but for vague talk of a bid to take the company private. That too may be more wishful thinking than anything else, for at their current level, the shares stand on a slightly higher forward earnings multiple than Tesco, Britain's pre-eminent retailer.

Who in their right mind would buy Sainsbury's when they could pay the same for Tesco? The only possible case that can be made for it is the company's substantial property portfolio, some 60 per cent of which is freehold. According to City estimates, this may be worth some £5bn, which is higher than the company's stock market valuation. Much store is being placed in the strategy statement Justin King, the still newish chief executive, is due to outline in two weeks' time, yet it is hard to see what he can say that will make the picture at Sainsbury's look significantly better. A big cut in the dividend is inevitable, further undermining the case for holding the shares.

If Sainsbury's can no longer compete on the asset base it has, then it must slim back to a more profitable core. It is hard, though not impossible, to sell a strategy to the City that involves halving the sales and flogging off the bulk of the assets, but that may ultimately be the best way of realising value. Mr King has a virtually impossible task in making Sainsbury's grow again, and his chances of delivering a decent return on capital have been harmed, possibly beyond retrieval, by the £3bn of sunk capital his predecessor, Sir Peter Davis, invested in a spanking new distribution system.

It's always darkest before the dawn, Mr King will insist when he kitchen sinks the business for a second time this year at his strategic review in two weeks. The family is said to have given him a pathetically small amount of time to deliver before they hare off down the private equity route. But I wonder, when they run the numbers, whether they will find taking the company private such an attractive proposition.

Shock ERM therapy

Conventional wisdom today ia very much that Britain's membership of the exchange rate mechanism (ERM) was a political and economic catastrophe, so many thanks to Sir Alan Budd for reminding us that it was in fact part of a wholly necessary and ultimately beneficial evolution in British macroeconomic policy. As chief economic adviser to the Treasury at the time, Sir Alan was very much part of those events, so naturally he's biased.

Yet in a lecture to the Wincott Foundation yesterday evening he gave as erudite and compelling a defence of the decision to join as I've yet seen. And he makes this startling claim: British membership was in fact "an economic triumph that marked the turning point in Britain's macroeconomic performance". History has been much rewritten for political ends since, so his observations bear some repeating. As Sir Alan points out, British macroeconomic policy was a mess throughout much of the 1970s and 1980s. Successive chancellors struggled to find anything to replace the discredited post-war tradition of demand management - using fiscal policy to keep unemployment low and direct controls on pay and prices to keep the lid on inflation. By the mid-1970s, these techniques had almost wholly broken down. As an alternative, policy makers allowed the exchange rate to float, and targets were introduced in an attempt to control the supply of money. It didn't work. By the mid-1980s, the pound was virtually at parity with the dollar, causing inflation to rocket once more.

Joining the ERM thus became the main plank in Britain's anti-inflationary policy. As members, Britain could enjoy the same price stability as Europe and ultimately benefit from its much lower long-term interest rates too. The effect was to induce a recession, but it also permanently brought down inflation, and, perhaps as important, inflationary expectations. As Sir Alan puts it: "Membership of the ERM forced the UK to maintain the policies which brought inflation down to the levels at which it has stayed ever since. Norman Lamont [chancellor at the time of Britain's exit from the ERM and the chief fall guy for our participation], in the role of Ulysses, was tied to the mast, his ears stuffed with wax, so that he was unable to hear the siren calls for reflation."

It was tough, unpalatable medicine, but it worked. Were there alternatives to what amounted to surrendering control of British monetary policy to the greater demands of the German mark? Sir Alan believes not. By luck more than judgement, in Sir Alan's view, Britain left the ERM at precisely the right moment, allowing both interest and exchange rates to ease, and the economy to begin gently reflating. Yet the policies that replaced it - an inflation target and independence for the Bank of England - would not in his view have been feasible in 1990 even if they had been politically acceptable.

Britain joined the ERM because it could not devise an anti-inflationary alternative. When the Bank of England was finally granted independence in 1997, it was not being asked to succeed where the politicians had failed, only to maintain an inflation rate that had already been brought under control. The Bank has done an excellent job in so doing, but Sir Alan is surely right in suggesting it would have found it hard to impose the policy medicine required to bring the inflation rate down from the 11 per cent that ruled before we joined the ERM.

The ERM was a cathartic experience which taught Britain how to control inflation. It became much more feasible to introduce an inflation target once the ERM had done the donkey work of bringing inflation down.

Sir Alan reckons we left the ERM at just the right moment and he insists that nothing in his lecture should be used to support the argument for joining the euro. Yet he's no way of knowing how Britain would have performed had we stayed in the ERM or indeed eventually joined the euro. It is one of those what if questions so beloved of producers of popular history series for prime-time TV.

What is certainly true is that Britain's ignominious exit from the ERM in October 1992 poisoned our relationship with other European policy makers, possibly irretrievably. They failed to come to Britain's rescue, as they should have done, when the pound was under speculative attack. It was an act of betrayal for which Europe has paid a heavy price in Britain's non participation in the single currency.

BT break-up

Drawing on his own experience as Britain's first electricity regulator, Professor Stephen Littlechild, now a research fellow at the Judge Institute of Management in Cambridge, reckons that a full scale break-up of British Telecom into wholesale and retail operations is the right way to go in almost every respect, from enhancing competition, to better regulation and more shareholder value. He's correct in this view, but nobody's going to listen to him.

Ofcom is almost certain to rule out an enforced break-up in phase two of its review of telecoms regulation, expected to be published shortly, while for both Sir Christopher Bland, BT's chairman, and Ben Verwaayen, the chief executive, it would be a resigning issue. Strangely, there's little appetite for it in the City either, even though it seems to me unarguable that it would deliver more shareholder value. Eventually Professor Littlechild's view will prevail, but its time has not yet come.