UK Edition
Questor: follow these two top 'contrarian’ fund managers and buy Sainsbury’s
Supermarkets have been good places for investors to avoid in recent years as the arrival of discounters such as Aldi and Lidl blew a big hole in their profitability.
So it’s not surprising that just three UK equity funds currently feature J Sainsbury among their top 10 holdings, judging by a quick search of the Morningstar database.
When stocks are this unloved by the market as a whole they tend to attract the attention of “contrarian” investors – those who agree with the great investor Sir John Templeton when he said “you can’t outperform the market if you buy the market”.
Among the most enthusiastic followers of the contrarian creed is Alastair Mundy, who manages the Temple Bar investment trust and has recently added Sainsbury to the portfolio; he already held Tesco and Wm Morrison.
He said Britain’s incumbent supermarkets had started to compete more successfully against the discounters by improving quality and cutting prices.
“Consequently, the extraordinary sales and profits growth of the discounters has probably peaked and the market’s assumption of sizeable market share increases over the next few years may be too optimistic,” Mr Mundy said. “This increases our confidence that the larger food retailers can continue their recovery and so we have added J Sainsbury to the portfolio.”
He added that lower capital expenditure and the return of food price inflation would also benefit the traditional supermarkets.
Mr Mundy said Sainsbury’s valuation had “begun to look somewhat anomalous versus that of its peers”: if you looked at “enterprise value” (in effect, how it would be valued by the stock market if it had no debts), Sainsbury was currently valued at about 25pc of its sales whereas Morrison and Tesco were valued at more than 40pc of their revenues.
He also said Sainsbury’s purchase of Home Retail Group, the owner of Argos, could prove a “compelling” deal as it would allow the group to make more productive use of excess space and drive significant footfall while creating an enterprise with more than 2,000 collection points.
He admitted that the deal involved some risk, in terms of management distraction and pushing Sainsbury’s more into competition with Amazon, but said it was adequately reflected in the share price.
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Capital at risk
Another high-profile manager to hold the shares is Julie Dean, formerly of Schroders and now at Sanditon Asset Management.
She told Questor: “Supermarkets are relatively defensive shares – more attractive at this stage of the business cycle than more cyclical consumer stocks such as leisure and general retailers, where we think it’s got as good as it’s going to get for the consumer.
“Sainsbury’s is showing stabilising core earnings, which we anticipate can improve, and Argos is performing well.”
She concluded: “Sainsbury shares are cheap in their own right and trade at much lower p/e multiples than Tesco and Morrison and with a higher dividend yield.
“The shares are 'unloved’ and have underperformed their peers over the past 12 months, but earnings forecasts should start to go up and significant growth in free cashflow will lead to a cleaner balance sheet – this leaves scope for a higher p/e multiple, from current low levels of about 11 times earnings for 2018, on a rising earnings stream.”
We rated Sainsbury’s a sell at 251.1p in June last year, seeing the shares as expensive at the same earnings multiple of 11 at a time when profits were falling. We feel that these managers may have caught the bottom of the group’s fortunes and suggest that you follow them into the stock.
Questor says: buy
Ticker: SBRY
Update: Staffline
Staffline, the fast-growing recruiter that we tipped last month, yesterday announced another acquisition, of an Irish firm called Oak Recruitment. In our tip we wrote that Staffline would probably need to make further acquisitions to meet its "burst the billion" target - sales of £1bn.
Ken Wooton, manager of the Wood Street Micro Cap fund, holds the shares. He said: “The activity and geographical location of Oak Recruitment are right on message in terms of the strategic priorities Staffline has set out.
"Although the revenue numbers for Oak have not been disclosed, every little helps in terms of getting Staffline closer to its ‘burst the billion’ revenue target for 2017.”
Mark Slater, who holds the shares in his Slater Growth fund, added: "The market is still pricing Staffline as if it will have great difficulty adapting to a post-Brexit world and will struggle to replace government contracts. However, management has shown a great ability to adapt to change.
"Trading on a p/e ratio of less than 10 with a free cash flow yield of more than 10pc, I’m very happy to continue backing the business."
Investment trust news
Because of the Budget there will be no Questor column tomorrow, so today’s column incorporates investment trust news.
Angus Tulloch, the renowned emerging markets investor, is to retire from Stewart Investors in September.
Scottish Mortgage investment trust is to cost less: from April 1 the annual management fee charged by the investment manager, Baillie Gifford, will continue to be 0.3pc on the first £4bn of assets under management, but will fall to 0.25pc thereafter.
Foreign & Colonial investment trust has announced its 46th consecutive annual dividend increase.