Are J Sainsbury Earnings Growing Stale?

October 14th, 2011 by

Although the European financial crisis has hit financial institutions the hardest, other industries are not immune. J Sainsbury (SBRY LN) is an example of a grocery and convenience store chain that is feeling the pain. Its core business is under competitive pricing pressure and its expansion faces competition from online stores without the brick and mortar overhead.

According to our StarMine Earnings Quality (EQ) Model, sustainability of the company’s earnings is yet another concern. SBRY LN currently has a StarMine EQ score of 9 out of 100, placing it firmly in the bottom decile of companies in the region. Let’s examine some of the factors that result in this low score.

SBRY LN owns the majority of its property and continues to invest in more stores. As can be seen in the chart below, from September 2007 to present, CapEx has exceeded cash flow from operations in 6 out of the 8 semiannual periods. It would appear that the company is unable to fully self-fund its expansion and must instead rely on outside sources of capital. Not optimal if we find ourselves in another credit crunch.

CapEx vs. Cash Flow from Operations
Source: Thomson ONE / StarMine

Making investments for the future by expanding a business is not necessarily a bad thing. However, it might be if the company is not earning an adequate return on that investment. A good measure to examine is return on net operating assets (RNOA). It’s another way of looking at return on invested capital and a measure of a company’s operating efficiency. Companies with low returns tend to underperform in the future. In this next chart we see that, since inception, the company’s RNOA has lagged the sector median. By this measure, it appears that shareholders are receiving a subpar return on management’s investment.

Return on Net Operating Assets
Source: Thomson ONE / StarMine

It’s also noteworthy that the gross margin for SBRY LN is 7.9%, much lower than the industry median of 21.1%. As higher margin online operators continue to gain popularity, one thing potential investors may want to keep an eye on is whether the bricks and mortar strategy of SBRY LN can generate satisfactory growth and returns.

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