UBS has raised its target price for J Sainsbury plc (LON:SBRY) – a day ahead of the supermarket group’s first-quarter trading update – as it thinks risk-reward for the stock looks attractive after including Asda into its model.
Repeating a ‘buy’ rating on the stock, the Swiss bank’s analysts hiked their target for the FTSE 100-listed stock to 400p from 325p, with the shares currently trading at 319.3p, up 0.7% on Monday’s closing price.
READ: Barclays Capital now assumes an 80% chance of success for the proposed Sainsbury's/Asda merger
In a note to clients, the UBS analysts said incorporating Wal-Mart Inc (NYSE:WMT) owned Asda - which Sainsbury’s agreed to merge with earlier this year, subject to regulatory clearance - into its model and pro-forma financials suggests material upside.
They pointed out that as £500mln in net synergies mature, their earnings per share reaches 0.35p per share and estimated free cashflow of 0.37p per share, while it estimates fair value at 450p per share on 'through-cycle' multiples.
The analysts added: “With gross cost synergies of c.£1.3bn, Sainsbury's has £700mln-£800mln firepower to invest in the customer - enough to cut prices by c.250bps (basis points).”
They also noted that if the Asda deal 'broke', their standalone fair value of 265p per share suggests a positive skew on the range of outcomes.
Remedy store disposals
The analysts pointed out that Sainsbury’s management expects deal clearance to be conditional on a number of remedy store disposals.
They said; “Our base case sees a modest 28-54 remedy stores (2.4%-4.5% combined estate). Excluding 'discounters' as competitors, though, this would rise to 132-161 stores (11.0%-13.5%).”
The analysts also pointed out that neither the companies’ guidance, nor their estimates, assume any revenue synergy upside.
But, they said, they have identified a potential underlying earnings (EBIT) opportunity from cross-selling Sainsbury's Bank and Clothing, and introducing the Nectar loyalty scheme to Asda .
The analysts noted that Sainsbury's recent acquisition of the Argos stores chain also stands to be a beneficiary, calling Asda its 'natural home', with UBS research showing the US-owned supermarket group’s shoppers are the heaviest Argos 'cross-shoppers' of any UK grocer.
They concluded: “Accessing Walmart's global procurement (buying book c.25x > than Argos) should help improve terms of trade, and its technologies (e.g. Parcel Tower; Jet.com) can further enhance the offer.”