UK's Sainsbury's warns higher cost prices making life harder

By James Davey

LONDON (Reuters) - Sainsbury's, Britain's second biggest retailer, cautioned that cost price pressures would weigh on its business this year as it reported a small decline in underlying sales over the last three months.

An almost 18 percent devaluation of the pound versus the U.S. dollar and a 12 percent fall against the euro since last June's Brexit vote, which has driven up import costs, combined with commodity price fluctuations, is making life harder for Britain's supermarkets.

"When we talk about uncertainty those factors weigh very heavily on underlying cost prices and therefore retail prices," Sainsbury's Chief Executive Mike Coupe told reporters on Thursday.

"We would acknowledge that we've gone from an environment which has been deflationary for two and a half years to being inflationary," he said.

While a return to food price inflation, in moderation, could be welcomed by investors in grocery stocks as it can boost sales and profit margins, the flip side is that rising inflation could begin to squeeze consumers' purchasing power.

Coupe said Sainsbury's, which last year expanded in areas such as electrical goods when it bought Argos-owner Home Retail for 1.1 billion pounds ($1.4 billion), had done a lot to mitigate cost price pressures within its supply chains and would continue to cut costs to try to limit price rises for shoppers.

Coupe, who did not give any specific margin or sales targets, believes Sainsbury's is well placed to handle the pressures, pointing to growth in the areas where it has heavily invested, namely at Argos and in clothing, convenience stores and online.

Morrisons, the smallest of Britain's "big four" supermarket groups and clear market leader Tesco have been setting the recent pace in sales growth terms.

The "big four" which also includes Wal-Mart's Asda have had to respond to the growing presence of German discounters Aldi and Lidl.

Shares in Sainsbury's were down 0.6 percent at 270 pence at 1122 GMT, paring its 2017 gains to 8.2 percent.

ARGOS SHINES

Sainsbury's sales at supermarket stores open over a year fell 0.5 percent, excluding fuel, in the nine weeks to March 11, the last quarter of its financial year. That compared to analysts' forecasts ranging down 1 percent to up 0.3 percent

After adjusting for this year's later timing of Mother's Day and Easter the outcome was in line with its third quarter when like-for-like sales rose 0.1 percent, it said.

The results showed a strong performance from Argos, where underlying sales increased 4.3 percent, accelerating from growth of 4.0 percent in the previous quarter and ahead of analysts' forecasts.

Rivals Morrisons and Tesco are both in turnaround mode after going through disastrous periods while Sainsbury's market share has remained broadly stable over the last five years.

Its profits have still fallen however.

Analysts are on average forecasting a 2016-17 pretax profit of 578 million pounds, which would be a third straight year of decline, despite the boost to earnings from the Argos deal.

HSBC analyst David McCarthy also argues that sterling's fall could wipe out all the synergies of the Argos deal.

"As we progress through 2017, we expect life to get tougher for Argos and consumers. Argos will see rising costs and input prices, while consumers are likely to see a decline in discretionary incomes," said McCarthy who has a "reduce", rating on the stock.

($1 = 0.8165 pounds)

(Editing by Keith Weir)