Rewards in sight at Sainsbury

The Investment Column

Sainsbury has been guilty before of seeing the green shoots of recovery only to be proved premature in its optimism. This time, just maybe, the once-great stores group could be right. There was a distinct air of improved confidence among the management yesterday and David Sainsbury, for the first time in ages, did not look like a man harassed.

True, a 4.2 per cent increase in same-store sales in the seven weeks since the year-end is hardly breathtaking. It is still some way short of Tesco's recent 6 per cent figure, but Sainsbury does seem to be edging in the right direction. The equivalent figure was 3.7 per cent in the second half and just 2.7 per cent in the first.

These gains have not been achieved without considerable costs, of course. The launch and running costs of the Reward loyalty card have been expensive and longer store opening hours have brought a higher wage bill.

Sainsbury's shares rose 3p to 349p after the City warmed to a firm message on cost control and the introduction of specific financial targets for various parts of the group. Shaw's, the US supermarket operation, is budgeted to improve its return on net assets from 10 per cent to 15 per cent by 2000. In the DIY business, the old Texas Homecare stores, which contrived to lose pounds 29m last year, are meant to improve like-for-like sales by 5 per cent, while the Homebase stores have been set a margin target of 7- 8 per cent.

In supermarkets the recovery will take time. Profits there were 11 per cent lower at pounds 661m and margins fell from 7.3 per cent to 6.2 per cent due to the petrol price war, which cost pounds 23m, the loyalty card costs and price reductions. This year, however, the company expects stable food margins and higher returns from petrol after the abatement of the price war.

Chief executive Dino Adriano has said he will not chase Tesco's number one market share position for its own sake but will judge the company on other goals. With just 43 per cent of the UK grocery market, Sainsbury feels there is still room to grow market share at the expense of smaller operators.

And there is evidence the group is winning more higher-spending primary shoppers.

In DIY, the integration of the Homebase and Texas operations has been harder and more expensive than anticipated, but prospects are encouraging with a benign climate and strong market position. The former Texas stores should be making pounds 40m profits in a few years.

Sainsbury's shares have taken a terrible pounding in the last few years and the glory days of supernormal profits are probably gone for ever. The market is just too competitive. But with such a strong brand franchise and signs of sales recovery, it is starting to look an attractive investment. On current year forecasts of pounds 704m, the shares trade on a forward rating of 14, which is a discount to most of its main rivals. A true recovery could take two to three years, but patience should be rewarded.

Whitbread offers

heady brew

Peter Jarvis, the veteran chief executive of Whitbread, is leaving the stage at Britain's fourth-biggest brewer on a high note. Unveiling his last set of results yesterday, he was able to announce both record profits, up 6 per cent to pounds 303m in the year to 1 March, and the group's biggest-ever share of the UK beer market at 15.3 per cent. The 14 per cent rise in underlying profits represents a tough target for Whitbread's rivals to beat.

Against the background of a total beer market which continues its gentle decline, Whitbread's ability to raise its beer profits 11 per cent to pounds 49.9m was a notable achievement. It is testimony to the efforts of Mr Jarvis over the past 12 years in focusing on premium lager brands such as Stella Artois, where take-home sales of over pounds 100m last year put it ahead of better-known names like Heinz baked beans or Kellogg's cornflakes.

But beer is now just 13 per cent of profits and Mr Jarvis's real achievement is in building brands like Travel Inn and TGI Friday's in growth areas of the leisure market, such as hotels and dining out.

With most of the past two years' pounds 500m acquisition programme centred on such areas, the restaurants and leisure division saw profits soar from pounds 88.3m to pounds 122m.

David Thomas, Mr Jarvis's successor, was yesterday confidently looking forward to Whitbread becoming the UK's leading leisure company.

Certainly a large chunk of this year's capital expenditure budget, which is likely to top the pounds 409m spent in 1996/97, will go into leisure projects, including 19 new David Lloyd leisure centres and another 35 Bella Pasta restaurants.

If Mr Thomas can maintain the juicy rates of return the group is already achieving on its capital programme - up to 25 per cent on redevelopment of existing sites and 16 per cent on new ones - the 250 new openings planned this year should please shareholders as well as corporate egos.

Meantime, profits of pounds 355m would put the shares, up 6.5p at 796.5p, on a forward price-earnings ratio of 15. With little sign of the consumer boom petering out and Labour making positive noises about the industry, that still looks reasonable value.

RBS looks for southern deals

Considering its position as a rock-solid pillar of the Edinburgh financial establishment, the Royal Bank of Scotland's share price has given shareholders a pretty hairy ride over the past year. Takeover talk, with Royal alternately touted as both bidder and target, is the main driver, although neither scenario seems a rational explanation for a share price that has bounced around since last summer between 630p and 469p.

George Mathewson, Royal's forthright chief executive, dismisses rumours Halifax has the bank in its sights. He is probably right given Royal's strength in corporate work, which would hold little attraction for the retail giant. In fact, it is hard to see who might afford the bank, which is valued at pounds 5bn, without severe earnings dilution.

As for Royal as a bidder, no secret is made of its desire to snap up a building society. With 35 per cent of the Scottish market, it desperately needs to acquire a customer base south of the border through which to cross-sell its other insurance and long-term savings products, but the prices at which the former mutuals are coming to the market rules out any imminent deal.

Profits in the half-year to March of pounds 369m, a 23 per cent increase on last year's pounds 301m, were solid enough, especially given the second duff year in a row for Direct Line, the telephone insurance arm. Profits of pounds 8m were an improvement on last time's pounds 5m, but a miserable return on capital. Claims the motor insurance cycle is set for a sharp uptick appear to be a triumph of hope over experience.

Elsewhere, UK banking was boosted by an impressive 4-point decline in the ratio of Royal's cost base to its income, although the roll-out of the joint venture with Tesco, sensible as the move is, will increase overheads in the second half. The US arm, Citizens, looks in remarkably good shape considering the record thus far of UK banks' diversifications in America. On the basis of forecast profits of around pounds 730m this year and earnings per share of 50p, the shares, down 0.5p at 585p, trade on 12 times earnings. With a dividend yield of 4.6 per cent, that is about fair.