This week, the news broke that Sainsburys (LSE: SBRY) has reached a deal to buy Argos owner Home Retail Group. The proposed merger, which values Home Retail Group at around 1.3bn, will result inHome Retail investors swapping each share for 0.321 Sainsburys shares and 55p in cash.
In my opinion, this is a bad deal for Sainsburys shareholders. Sainsburys grocery business is already outperforming the other big three supermarkets, with a slower pace of like-for-like sales decline and better market share retention. Trading conditons are challenging for the supermarket, but at least they are beginning to stabilize. By contrast, Argoss outlook appears to be worsening, as like-for-like sales fell 2.2% in the 18 weeks run-up to the New Year, indicating the worst may not be over.
Strategically, a merger looks risky and seems to present few worthwhilesynergies. Sainsbury has already been incorporating Argos concessions within its larger stores, and it should be able to roll-out further concessions without a complete takeover. This would remove much of the integration risks of bringing together two rather different businesses, and would be less of a distraction to management at a time when both sectors are undergoing some very significant structural changes.
On the financial side, the deal is cleverly structured so that Sainsburys retail banking arm would finance the acquisition of 600 million worth of consumer loans on Argoss balance sheet. This allows it to raise up to 500m in cash from savers and thus reduce the burden on its own cash reserves. Nevertheless, free cash flow generation will likely worsen as Argos has additional investment needs in order to restore profitability.
Sainsburys dividend was cut by a third back in May 2015, and it looks as if further cuts will come within the next two years. With dividend uncertainty surrounding the stock and a risky acquisition strategy, I would rather stay out of Sainsburys shares.
Centricas (LSE: CNA) adjusted net income is expected to fall by 8% this year, after a 28% decline last year. A collapse in upstream profits following the downturn in energy prices over the past 18 months is mostly to blame, but increased competition in its supply business and unusually mild winter weather are also causes. Shares in the vertically-integrated utility company now yield 6.9%, but with earnings declining, its dividend could be cut again this year.
As energy prices continue to decline, Centrica will find it increasingly difficult to divest from its portfolio of upstream assets, and the continued ownership of these assets maylead to further momentum in the decline in earnings for the group. Furthermore, capital spending requirements to maintain production levels would burn through cash flow generated by its retail supply business, reducing the cash available for dividends.
Meanwhile, interdealer broker Tullett Prebons (LSE: TLPR) dividend looks more secure. Its dividend is covered by almost twice earnings, and its earnings outlook is far more optimistic. A rise in market volatility, industry consolidation and cost savings should lead to growth in profitability. Earnings have been unusually weak as of late, but trends are finally looking up.
City analysts expect adjusted net income to have fallen 2% in 2015, and that 2015 should mark the bottom of the market. For 2016, adjusted net income should rebound by 11%, giving its shares a very appealing forward P/E of 9.2. Growth in earnings should support growing dividends too, and analysts expect dividends will grow 3%, to give its shares a prospective yield of 5.4%.
With the best dividend outlook of the three, I would rather buy Tullett Prebon.
Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended Centrica. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.