J Sainsbury PLC

LSE:SBRY

Earnings Call Transcript 2020-Q4

[Kevin O'Byrne, CFO, Member of the Operating Board & Director]

Good morning, everyone, and thank you for joining Mike and I for our preliminary results presentation for the year to March 2020. We hope you're all keeping well and safe just now. And we're clearly in very unusual times, and therefore, we will run the agenda slightly differently today.Firstly, I'll run through the financial results. Mike will also give some brief words on the past year, and then cover COVID-19 and the outlook, as clearly COVID-19 has significant bearing on that.For those listening on the morning of our results, we're running a Q&A session separate from this at 9:30 a.m., and for anyone listening later, the recording of the Q&A session will follow on at the end of this presentation.Turning to the headline numbers. Sales were broadly flat with Grocery and Clothing growth, offset by declines in General Merchandise. Retail profits were down 4% year-on-year, reflecting tough comparatives and marketing investment in the first half, General Merchandise weakness, and a change in transfer pricing, which had the effect of switching around GBP 10 million of profits from Retail to Financial Services. Overall, we had a better performance for both Retail and Financial Services in the second half.Free cash flow generation was strong and included GBP 127 million relating to the sale of stores in the British Land joint venture. Non-lease net debt reduced by GBP 343 million or 23%, in line with our ambition to reduce net debt this year by at least GBP 300 million. Statutory pretax profits of GBP 255 million were up year-on-year after exceptional items that were lower year-on-year. These exceptional items were almost entirely noncash, and I'll cover more on that later.A couple of things to pull out on this sales momentum or sales movement slide. First is the weakness of General Merchandise, which is the main driver of the supermarket sales decline. Second is a weaker convenience number than you're used to seeing. This reflects fewer openings in the year but also the store closures that we announced in September at our Capital Markets Day. Guidance-wise, you can see the balance of opening and closures anticipated this year. These plans are subject to the impact of COVID-19, and that is particularly the case with Argos.Looking at the momentum of sales over the course of the year, the key highlight for us has been the customer response to the changes we've made to the value of our Grocery offer and the investments we've made in the store of space. There is some benefits from about a week of COVID-19-driven stockpiling in quarter 4. But even without it, it would have been in healthy positive territory.With General Merchandise, it's important to make the distinction between double-digit declines in Sainsbury's stores and sales in Argos, which have seen some impact, but clearly a better trend, albeit not without challenges, particularly in some key categories like toys and gaming.We delivered a good Clothing performance with strong online growth and good full price sales growth. Picking up on the momentum point, the Grocery volume charts are on comparative periods and shows the clear progress we've made relative to our competitors over the course of the year, although it's fair to acknowledge that quarter 4 was against a weak performance in the prior year.Argos sales growth dipped below the BRC average over the course of the year, reflecting the performance of some categories like toys and gaming, which I've mentioned, which are far bigger in the Argos sales mix than the BRC average. Clothing showed a consistently strong performance against a weak clothing market.The moving parts of the headline profit number are pretty clear. Again, the change in transfer pricing arrangements benefited Financial Services at the expense of Retail to the tune of around GBP 10 million. Also, we delivered GBP 19 million from lower interest as we continue to reduce net debt and benefit from having paid down some of our more expensive debt instruments, regarding the interest cost being GBP 20 million to GBP 30 million lower next year also.Joint venture income reduced, given the British Land property sales. Only a negligible joint venture income is expected now, given this and the fact that Nectar is now being fully consolidated. This chart also draws out the difference between H1 and H2, with Retail in H1 impacted by higher marketing spend and tougher weather comparatives, also a significant difference in colleague wage inflation in the 2 halves and Financial Services improvement in the second half.The big headline exceptionals number this year is material, but 90% of it relates to the property strategy program we announced in September and is almost entirely noncash. We've revisited the property strategy program we announced at the Capital Markets Day in September, bringing in some additional closures. So now, one-off costs are expected to be in the region of GBP 330 million to GBP 350 million, of which we booked GBP 296 million in the year just completed. This compares to a maximum initial expectation of GBP 270 million. And again, the cash element of this is very limited at only around GBP 50 million.We said that the cash cost of exceptional this year will be less than GBP 100 million, and that has been the case, coming in at GBP 71 million, including the bank, and this includes cash costs relating to some exceptionals booked to the P&L in the prior year.Looking at the Financial Services profit contribution in the wider sense that we introduced last year, profits grew by 10% with selective lending growth driving income, whilst focusing on capital efficiency.Net income was up GBP 4 million, driven by good performances on travel money and banking fees. Impairments also benefited from an alignment of impairment policy between Argos Financial Services and Sainsbury's Bank.Lending-wise, you can see the early impact of the change in strategy with personal loan balances down year-on-year and stronger growth in lending linked to our retail customers through the Sainsbury's Bank credit card and the Argos store card. The increase in mortgages reflects the fact that we didn't stop offering new mortgages until September 2019, and retail deposits increased by 5% to support the growth in the mortgage book. We expect to see our retail deposits reduce as mortgage book runs off.It's still early days on the new bank strategy, and that's reflected in our cost base, which is up year-on-year. However, the headcount chart is a good leading indicator of the changes we've been making, as is the success of the Argos Financial Services mobile app and move to a lower cost-to-serve banking model that we will extend across other products.Clearly, COVID-19 will have a big impact on the outlook for the bank, both short term, which Mike will cover later, and in terms of 5-year targets, which we will come back to later in the year.You can see here a step-up in CapEx this year as we accelerated some programs, reflecting, in particular, our confidence in the store investments we've been making. We continue to guide to GBP 550 million to GBP 600 million of CapEx in the medium term, although, again, the timing and size of this in the year ahead could be influenced by COVID-19.We're very pleased with the strong underlying cash flow and net debt reduction with net debt, excluding leases, down 23% year-on-year. Higher CapEx was broadly offset by reduced capital injections into the bank. We made good progress towards our target of GBP 750 million net debt reduction over 3 years. Mike will talk about the impact of COVID-19 on the outlook later on. On the basis of our base case expectations for the year ahead, there's no need to change this outlook. But clearly, as per the guidance we've given, it carries a big caveat, given the significant uncertainties relating to the development and ultimate impact of COVID-19 on the business.So in summary, we're very pleased with the strong customer response to changes in our Grocery business. General Merchandise remained tough. We made good progress on our Financial Services plans. And H2 profit growth was strong, and we delivered strong free cash flow and net debt reduction in line with our guidance.I'll now hand you over to Mike.

[Michael Andrew Coupe]

Thank you, Kevin, and it's my last results presentation in extraordinary circumstances. And can I start by thanking our colleagues, who've been absolutely amazing in the way they've adapted to the changes in our business in the last 8 or 9 weeks. And as Kevin has already said, I'm going to present my part of this presentation in 2 sections. First of all, I'm going to reflect briefly on last year, and then secondly, I'm going to talk about our response to COVID.So if I turn to Slide 18, we communicated at our Capital Markets Day that our purpose was to help our customers live well for less and that we have a series of priorities, starting with the need to be more competitive on price; offering distinctive products and categories; to offer personalized and seamless physical and digital experiences; to offer fast, friendly and convenient shopping; to drive efficiency to allow us to invest in our business; to be a place where our colleagues love to work; and we've added, in January, another objective, which is to be a Net Zero greenhouse gas emitter by 2040.And it's fair to say we've made a lot of progress against the objectives that we set at the Capital Markets Day, and that particularly emphasized, given the situation with COVID-19. And as we've seen during the year, our performance has improved sequentially, and certainly, our volume share has stepped up and actually grew in quarter 4. Now it's always difficult to attribute the performance to any particular thing, but we would say it's as a result of a combination of a number of the actions that we've taken.If you move on to Slide 19, you can see that we've demonstrably improved our overall pricing, whether it's against the discounters in the form of Aldi or against our mainstream competitors such as Tesco. And we've done this by launching the 200 items that we talked about at the Capital Markets Day, [ owning ] price point products; secondly, by improving the pricing and commodities by reducing or holding the price of 2,500 products; and lastly, by improving the weight of promotions in our business, particularly through our lockdown mechanism. And we're pleased that the Which? magazine actually recognized us as the cheapest supermarket for branded groceries in 2019.So if we move to Slide 20. We've delivered a series of major growth initiatives in '19/'20. So we've made 12,500 investments, investing GBP 164 million. We've touched around about 3/4 of our supermarkets, almost half of our convenience stores and around half of our Argos stores. So for instance, we've introduced 124 beauty departments. We've put Rapid Exit and SmartShop in 118 stores. We've improved Tu clothing in 110 stores. We've put Food to Go in 210 of our convenience stores and improved the Ambient range in 250, and we've digitized 256 Argos stores. We've also closed underperforming space and opened a number of new convenience shops and a couple of supermarkets. And we've also actively repurposed our space where we can.If I move to Slide 21. We've also seen a significant improvement in our customer satisfaction rating. And let's take an example of ease and speed of checkout, as a result of our investment in things like SmartShop and self-checkouts, we've seen that rating moved significantly forward by our customers. And of course, more recently, despite the fact that we saw a short-term step-down in our customer service during the course of March, we've seen a very significant increase in our CSAT measures during the course of April as a result of our customers' response to our response to COVID-19, which I'll come back to in a minute. But overall, our supermarket measures have improved year-on-year in terms of customer satisfaction.I'll talk briefly about our Convenience business. We've launched a couple of new formats, firstly, our On the Go format in Mansion House, which has proven to be very successful, as is our Neighbourhood hub store in Woodhall Spa. We actually saw a strong performance in our Convenience business, growing by 1.3% despite the fact that we closed 27 stores in the year and only opened 13, so a net space reduction.Groceries online, pre-COVID, was also growing very strongly. We've seen roughly 7% compound growth every year for the last 5 years. And of course, we've also seen a significant improvement in our overall efficiency. So our pick rates, our items picked per hour, as an example, have actually improved by over 40% over the last 3 years and by 14% in the last year. But again, post-COVID, we've seen a very significant increase in the uptake of online groceries from our customers, and I'll come back to that in a minute.So moving on to Slide 24 and let's talk specifically about our Financial Services. And again, at the Capital Markets Day, we laid out our priorities to reshape our balance sheet, to simplify our organization and to strengthen our business. And we've made significant progress in this direction although, of course, there's still lots to do. So for instance, we've stopped mortgage origination. We've improved our margins. As Kevin has already referred to, we've lowered our cost base, and we're increasingly focusing our business on building digital propositions, not least in Argos Financial Services. We've simplified our organization, and we're rightsizing our business for its current sales by improving our cost base. We're rationalizing the product offering, and we're reviewing all of our vendor and supplier arrangements. And lastly, we're strengthening our business through operational resilience, through our conduct and through our capital efficiency, and building on our core competencies in customer experiences and digital.So I move on to Slide 25. Also, we've seen our Nectar business progress significantly in the last year. So at the Capital Markets Day in October, we were just about to launch the Nectar Digital proposition. And we've seen that now downloaded by 4.5 million regular users, which is tremendous progress from nothing in October. We've strengthened the coalition, bringing on Esso, Sky, Sky Store and Argos. And we've extended the proposition more widely across our business. And we've also launched Nectar 360, and that gives us the ability to not only use insight in our business more regularly but also gives our suppliers to access information about our customers. And of course, when we combine this with SmartShop, it acts as a very powerful tool for our suppliers and ourselves to be able to talk to our customers in real-time. And we offer Nectar points more widely across our business, both in our stores and in our digital real estate, which acts as a currency that can work both within and outside our organization.If I move to Slide 26. It's important to reemphasize the way the business has become more and more digital during my tenure. And we've moved the digital sales in 2014/'15 from GBP 1.1 billion to, in the last year, GBP 6.3 billion, and I suspect post-COVID, it will move a lot higher than that.We've now rolled out SmartShop into all of our supermarkets. And at the end of the year, our participation, our sales participation in our handset stores was around 18%. Now clearly, it's moved a lot further forward more recently. And last but not -- by no means least, we're joining together our digital proposition and our real estate and increasingly digitizing all of our properties, whether that's Nectar, whether it's the bank and Argos Financial Services, whether it's SmartShop and also introducing universal search.Moving on to Slide 27. We've also maintained our focus on reducing our costs. And we talked about a strategic cost transformation program not only covering off the cost of inflation, but also further reducing our costs by GBP 400 million to GBP 600 million over a 5-year period of time. And we're well on the way to executing that plan.So for instance, we've completely integrated our operations now, retail operations, marketing and commercial operations. So the company is now fully integrated. We're already delivering against our property strategy, as already talked about, and Kevin has already talked about. And we're starting to get on with delivering the other cost transformation projects, so not least in our logistics and supply chain. And you've seen a recent announcement about our work with Blue Yonder to further strengthen and modernize our supply chain as we look forward. So we're confident we've been able to deliver the strategic cost transformation plan despite the challenges that we have in the most immediate future.If I move on to Slide 28. We introduced our commitment to Net Zero greenhouse gas emissions by 2040 in January. And we think this will become a bigger part of our business, and indeed, our customers' mindsets as we look forward post-COVID. So as well as reducing our carbon emissions, we've talked about minimizing our use of water, helping our customers eat healthy and sustainable diets, reducing the use of plastic packaging, reducing food waste, increasing recycling and making a net positive contribution to biodiversity. And we're also committed to using science-based targets and to report progress against these targets every 6 months.So moving on to our response to COVID. We thought we'd start by showing you a time line of how much change has gone on in the organization in the last 7 or 8 weeks. And can I start by thanking all of our people, all of our colleagues, for the ways that they've responded to an incredible period of challenge and how flexible they've been. And it's a testament to the culture and the values of the organization, how we've responded to a particularly challenging set of circumstances for both our business and societally, more widely.And we started out with 3 specific objectives: First of all, to feed the nation; secondly, to make sure that we kept our colleagues and customers safe; and thirdly, that we set out to support the communities that we serve. And if we just go through the time line, it shows you how rapidly that we've responded to the challenges put in front of us. First of all, starting off with product purchasing limits; then to make sure that we help our colleagues by, first of all, committing to 14 days on full pay if they had to self-isolate, 12 weeks on full pay if they were vulnerable or if they were helping vulnerable people. We put in place priority shopping at the 22nd of March. We actually closed the Argos stand-alone stores on the 23rd of March. We gave our colleagues a bonus or committed to give our colleagues a bonus for the first trading period of our year as a result of their help and support. We've introduced social distancing measures right across our business. We had most of those in place by the 24th of March, the day after the Prime Minister announced a lockdown. By the 10th of April, we'd increased the number of online delivery slots by almost 50%. And actually, that represented an almost doubling of our online volume because, of course, our customers are ordering more when they ordered online. And we'd also contacted 800,000 vulnerable customers as well as donating GBP 4 million to Comic Relief's Big Night In.So moving on to Slide 31. What we've done here is laid out for you the sales shape of the various parts of our business, and we give you a detailed sales breakdown week-by-week in our RNS from week 50. As you can see, as you might expect, our Grocery business spiked very heavily, particularly in the early part of the year, in week 1 and 2. Secondly, we saw a peak in our General Merchandise business across the same period of time, particularly driven by Argos, although we saw a slowdown, and more recently, a slight step-up. Our Clothing business fell to minus 70% at the lowest point, although it's come back a bit more recently. And lastly, we've seen our Fuel business consistently traveling at minus 70% over the last 3 or 4 weeks.Now I'd emphasize that these numbers are actually changed for Easter phasing, so that we've made sure that we've trade-adjusted them, unlike the numbers in our trading statement, which give you the actual year-on-year comparative. So it's important to remember that these are actually smoothed to the effect of Mother's Day and Easter.If I move on to our Groceries online business. As we've already said, we set out from the very beginning to prioritize elderly, disabled and vulnerable customers and also to significantly increase our online capacity. And we've already referred to the fact that in the last few weeks, we've seen the number of slots available increase by almost 50%. And actually, because the order sizes are higher than we'd normally see, we've almost doubled our online sales as a proportion of our Grocery business. So that's moved from just under 8% to almost 15% in the last few weeks. And the efficiency of the business has also improved because the order sizes are higher, the drop densities because of the numbers of orders are higher, and we've introduced Click & Collect in more of our stores.It's fair to say the demand still remains high, and we're still not able to keep up with all of the demand that we have, and we'll continue to look to how we can increase the number of grocery slots in our business. And we believe that we'll get to around 600,000 delivery slots by the end of next week.If I move on to Slide 33. We talked about the fact that at the end of the financial year, the average participation of SmartShop in the stores with handsets was around 18%. And you can see in this chart how much that has spiked. So almost 1/3 of our sales are now going through SmartShop in these stores that have handsets. And that's, of course, good for our customers. It makes their shopping experience quicker and safer, but also good for our colleagues because it means that less of our customers are actually going through a checkout, and it increases the speed of our overall shopping experience.If I move on to the impact within Argos, you can see that overall, our average weekly sales have actually gone up, and that's even on the back of the fact that we've closed all of the Argos stand-alone stores. And you can see how much our home deliveries have grown, by 86% over the last few weeks and by 32% for Click & Collect. And we've seen roughly 9% growth in Argos since the beginning of the financial year.So as we look forward, we've talked in our RNS in some detail about our base case, but just to walk you through the various moving parts. We're making an inherent assumption that we'll be in full lockdown during all of quarter 1, and that effectively means until the end of June. And although we'll start to see some of the restrictions being lifted, we'd expect that there would be continued disruption right the way through the first half of our financial year, so effectively through the middle of September.We expect things to go back to more normality in the second half. However, we would expect the backdrop to be a weaker economy. And therefore, although we'd expect the grocery business to remain positive in the first half, we'd expect it to normalize in the second half, but we would expect that General Merchandise and Clothing will be down in the low double digits in the second half of the year on the back of the economy. We would expect the Fuel business to return something like normality.So those are the inherent growth assumptions that we've made as far as our base case on our sales outlook is concerned.If you think about the profit impact, if we look, there are 3 chunks that we've identified. First of all, there are a series of higher retail costs. So the costs of 25%, absence of peak, currently running at 15%. The fact that we paid a bonus to our colleagues, the fact that we've underwritten 12 weeks absent for our most vulnerable colleagues, obviously significantly increases our operating expenses. There's costs associated with stock clearance, a product that we're not going to sell, particularly in our clothing seasonal ranges. We expect to see reduced tenant incomes and concession incomes as a result of help that we're giving to both our leases and our concessionaires.We expect as a result of sales weaknesses that we'd see lower profits in our General Merchandise, Clothing and Fuel businesses. And of course, we'd expect an impact, as Kevin has already alluded to, in our Financial Services business. So for instance, we've closed our travel money. We're issuing a lot less cash because customers are using various other methods to pay. We've also taken some impairments on our balance sheet, and we'd expect reduced customer spend and an increase in colleague absence. So overall, we believe that there's going to be a profit impact in our base case of around GBP 500 million plus. And of course, there are a whole series of variables that could alter that in either direction.So if we move on to Slide 37, we've laid out our base case. So first of all, we'd expect our costs to increase by at least GBP 500 million, and that's because of the direct colleague costs that I've already talked about but also the profit impact of certain parts of our business. That will be offset by an increase in our Grocery sales and by GBP 450 million of business rates relief. We still, however, will pay business rates on our offices and distribution centers.So net-net, in our base case, we'd expect the impact to be neutral. However, I would caveat that by saying there is a high degree of uncertainty, and there are clearly scenarios that can go either way and quite significantly either way.So moving on to Slide 38 and looking at the business's liquidity. In all the stress scenarios we've run, we believe the company is more than adequately funded. In fact, we believe that we've got significant financing headroom. So to give you a couple of examples, at the end of the last financial year, we had GBP 1.45 billion of RCF undrawn at the year-end. We've drawn GBP 500 million of that down now, and we put that in our balance sheet for prudence. We also have our capital weighted towards the second half for obvious reasons because many of the things that we set out to do in the first half will not be done as a result of COVID.So turning specifically to our Financial Services business. Our balance sheet is strong. We have a regulatory capital surplus and significant excess liquidity, and we are confident that our Financial Services business will not require any capital from the group.So coming onto the dividend on Slide 39. We believe it is prudent for the company to defer the decision on paying a dividend. We believe that there are a very wide range of potential outcomes and that currently, we do not have fully enough visibility on the impact of COVID-19. And this, of course, will be greater in the latter part of this financial year.So we move on to Slide 40. In summary, we take our results for last year. We had great momentum in our Grocery business. We're coming together as one multi-brand, multichannel business, and we generated very strong cash. So as Kevin has already talked about, we reduced our net debt after leases by GBP 343 million.We've responded brilliantly to COVID, a great response right across our business, supporting our customers, colleagues, communities and our suppliers. And it shows the strength and flexibility of the multi-brand, multichannel platform that we have built. And our balance sheet strength is helping support suppliers, tenants and our concessionaires.As we look out, there are significant incremental costs associated with our response to COVID-19 and a duration that, that response is uncertain. The business rates relief is likely to offset the incremental costs and the weaker General Merchandise, Clothing and Financial Services contributions. But our balance sheet is strong, our liquidity is good, but we believe it is prudent to defer the decision on our dividend.Thank you very much.