|General Merchandise will be the focus after its online distribution issues hit Q3 growth. We forecast a sequential improvement in GM sales helped by an easier comparable. Food LFLs look likely to be steady. FY15 guidance should be maintained. While the shares may not push on with the Q4 update, we believe the recent re-rating may run further, especially if upgrades come through. We see a material gross margin opportunity over the next few years. We raise our TP to 580p (prev. 500p), based on the CY15 sector average PE.|
- We forecast Q4 GM LFL -0.4% (Q3 -5.8%) and Food LFL 0.3% (Q3 +0.1%). A sequential improvement in GM performance is expected now the online distribution issues seen in 3Q15 have been resolved. In addition online annualised the transfer from the Amazon platform in February (the start of its performance issues last year) and is up against easier comparables. We expect Food to have outperformed a tough competitive backdrop and may have benefitted from the recent underlying improvement in market conditions.
- International remains challenging with Russia a drag and further Euro weakness. While we maintain our overall FY15E PBT of £646m (consensus £641m), we cut International EBIT to £103m (prev. £125m) to reflect currency and have upped UK EBIT to £646m (prev. £628m) with a higher gross margin/lower cost growth assumption, and adjusted interest by £4m.
- Expect FY15 guidance to be maintained. GM gross margin +150bp to +200bp (INVe +195bps); Food gross margin +10 to +30bps (INVe +30bp) with UK opex up c.2% (INVe +2%).
- Valuation does reflect shift to cash generation. The shares have re-rated to an 8% sector discount, but we believe they still have further to go, especially if upgrades start to come through. We see a material gross margin opportunity, driven by better buying, lower mark down and general efficiencies. Our TP rises to 580p, based on a sector average CY15 PE multiple.