J Sainsbury PLC (LSE:SBRY) is pressing ahead with efforts to improve its Argos business after walking away from a sale earlier this year, but analysts believe the catalogue retailer would ultimately be better off under separate ownership, and that a deal may yet happen.
Shore Capital, the grocer's house broker, said management was right to explore a sale of Argos last year and equally right to walk away when the terms on offer from Chinese ecommerce group JD.com did not work for all stakeholders.
The episode was not without value, however, said Shore's head of research, Clive Black. The process "revealed a modus operandi where Argos could be separated," suggesting the groundwork for a future transaction has been laid even if the timing was not right on this occasion.
Since then, Sainsbury has created a dedicated Argos operating board under Graham Biggart, which the analyst feels will be watching for sequential trading profit progress as a welcome tailwind to the group's investment case.
In the meantime, Sainsbury is pursuing what it calls a "More Argos, more often" strategy to improve the non-food division's performance. Argos is also exploring the establishment of its own marketplace, which could broaden its revenue base.
Argos "has the basis to flourish in a more synergistic home" when the right opportunity presents itself, said Black.
Putting that to one side for now, the FTSE 100 group's financial year to 1 March has just ended amidst a strong backdrop of underlying trends.
Final results in late April are likely to show underlying retail earnings of just over £1 billion, according to Black, driven by consistent grocery market share gains including like-for-like sales growth of 3.4% in the third quarter against tough multi-year comparatives.
Looking ahead, underlying earnings of £1.07 billion are forecast for the coming financial year, with earnings per share of 24.7p and a dividend of 14.3p, implying a free cash flow yield of 7.3% and a dividend yield of 4.2%.
On capital returns, Sainsbury paid a special dividend of £250 million in the year just ended following the sale of its financial services business, and the Shore team expects a recurring buyback of around £200 million annually going forward.
Tough sales comparatives will be faced in the year ahead, particularly in the first half, with Middle East instability potentially re-igniting inflationary pressures through higher energy and freight costs, something it said it would be watching closely.
On valuation, Black argued that in a volatile world where technology stocks trade at elevated multiples, sound, asset-backed and cash generative UK supermarkets like Sainsbury harbour ongoing investor attractions, and said there is room for further rating expansion as the group continues to compound cash returns for shareholders.