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Edited Transcript of SBRY.L earnings conference call or presentation 7-Nov-19 9:30am GMT

Half Year 2020 J Sainsbury PLC Earnings Call

London Nov 13, 2019 (Thomson StreetEvents) -- Edited Transcript of J Sainsbury PLC earnings conference call or presentation Thursday, November 7, 2019 at 9:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Kevin O'Byrne

J Sainsbury plc - CFO, Member of the Operating Board & Director

* Michael Andrew Coupe

J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director

* Paul Mills-Hicks

J Sainsbury plc - Food Commercial Director & Member of the Operating Board

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Conference Call Participants

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* Andrew Philip Gwynn

Exane BNP Paribas, Research Division - Senior Food Researcher & Analyst of Food Retail

* Bruno Monteyne

Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst

* Clive W. Black

Shore Capital Group Ltd., Research Division - Head of Research

* Nick Coulter

Citigroup Inc, Research Division - Director

* Robert Joyce

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Xavier Le Mené

BofA Merrill Lynch, Research Division - Head of European Food Retail Equity Research and Director

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Presentation

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Kevin O'Byrne, J Sainsbury plc - CFO, Member of the Operating Board & Director [1]

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Good morning, everyone. Welcome to our results presentation covering the 28 weeks to the 31st of September. Thank you very much for joining us here in Holborn and for those of you joining us online. And I'm going to take you through some of the key financial highlights, and I'll hand over to Mike to talk about the operational achievements during the first half.

As many of you know, this is our first set of results under the delightful IFRS 16. We've published restated numbers for the half year and the full year in October. So hopefully, you've got all those.

The change, as you know, reduces our underlying profit before tax by about GBP 34 million in the full year, but has minimal impact on the total lease adjusted indebtedness of the group. And clearly, it has no impact on our free cash flow.

Underlying profit before tax for the period was down GBP 41 million year-on-year, slightly better than the pre-IFRS GBP 50 million guidance that we gave in September. Now about half of that difference is because of the lower IFRS 16 impact on half was slightly better outcome for the first half. And I'll cover the main P&L drivers, including the one-off costs in the financial services numbers on later slides.

In the period, we generated strong free cash flow of GBP 698 million, albeit impacted by some working capital, seasonal benefit, which is usually in the first half and unwind in the second half. Our full year net debt reduction guidance of at least GBP 300 million remains unchanged. And we completed the triennial valuation of our pension schemes during the period and agreed a new longer-term asset-backed funding plan, and we will pay an interim dividend of 3.3p per share, in line with our policy of paying 30% of the prior year's full year dividend at the interim.

Sales were broadly flat year-on-year, held back by tough comparators during the first quarter, in particular.

Retail operating profit was down 10% as guided in September, with the main drivers being the phasing of cost savings, poor weather against exceptionally good weather last year and higher marketing costs in the first half. We continue to make good progress in our cost reduction during the first half.

Financial Services profit increased by GBP 4 million, with a small underlying decline, offset by the benefit from the change in transfer pricing, which reallocated some profits from the retail business to -- into financial services.

Underlying interest cost of GBP 219 million is split by about GBP 49 million of what we call conventional interest costs, down from GBP 53 million last year, with the balance being charges relating to the IFRS 16 lease liability.

In the period, we booked a material one-off expense of GBP 229 million, largely relating to impairment and store closures following the store estate review, which we discussed with you in September, and these are largely noncash.

We, therefore, generated GBP 9 million profit before tax in the period. And as much of the write-down is not tax deductible. Our basic EPS after tax was a loss of 2.2p.

Growth in all categories was impacted by weather comparisons in Q1, with momentum, as you can see, improving significantly in the second quarter. Total retail sales are broadly flat and grocery sales increased by 0.6%.

We also delivered an improved performance in General Merchandise and Clothing in the second quarter.

Performance in all our channels were also impacted by the tough Q1 weather comparisons. But in addition, in supermarkets, we were impacted by -- in the first quarter by General Merchandise and Clothing weakness and our like-for-like growth in our convenience stores remains strong. This was also impacted at a total level by lower contributions from net new space.

And as you can see, Groceries Online continued its consistent track record of strong growth.

These charts show performance relative to the market across all 3 categories. Firstly, for Grocery, we show the progress we made with our volume performance over the course of the period relative to some of our key competitors. And you can see the improvement across the period.

On the right-hand side, you can see Argos sales growth continued to be stronger than a weak General Merchandise market. And finally, below that, you can see that in clothing, we consistently grew ahead of the market and gained share.

Financial services profits increased by $4 million, as I said, year-on-year, with a modest underlying decline offset by the benefit from the change in transfer pricing that we flagged.

This, as I said, moves profits from the Argos retail business into financial services, which is covering the cost of the capital employed and other financial services.

As you can see on the right-hand side of the slide, lending and deposits both grew significantly, mainly driven by the growth of mortgage balances from GBP 1.4 billion to GBP 1.9 billion. And this growth of the mortgage book was also the driver of the lower net interest margin and the lower bad debt ratio.

As we outlined at the Capital Markets Day in September, we stopped writing new mortgage business at the end of the first half, and we're currently reviewing options for the mortgage book.

The group injected GBP 35 million at the bank in the first half. And again, as we said in September, we expect to make no further capital injections. And we continue to expect financial services' underlying operating profit of GBP 45 million for the full year.

Looking to the wider definition of Financial Services profitability that we showed you at the Capital Markets Day, profits in the period were broadly stable year-on-year. The cost-income ratio was broadly flat and returns were down given the growth of the balance sheet.

As a reminder, our 5-year targets include doubling the profit and returns and the reduction of the cost-income ratio to around 50%.

One-off costs in the period was GBP 229 million. And as you can see, GBP 203 million of these related to the store-closure review we announced in September when we guided to a total cost of GBP 230 million to GBP 270 million for this program. It would be further profitability in the second half. These are predominantly noncash impairments, and we continue to expect total cash cost related to one-offs to be below $100 million for the year.

In September, we outlined plans to close 10 to 15 supermarkets, 30 to 40 convenience stores and 60 to 70 Argos stores during this financial year and next. And we expect to close 2 supermarkets, 25 convenience stores, around 20 Argos stores by the end of year.

Restructuring costs of GBP 25 million relates to reorganization of management structure in Argos stores and the closure of an Argos distribution depot.

Total CapEx fell year-on-year by around GBP 30 million driven by the end of the Argos integration program with underlying retail CapEx broadly flat.

We completed our triennial evaluation, as I mentioned during the period, with the deficit falling to GBP 538 million from GBP 1.1 billion in 2015. And we're very pleased. We've agreed a new long term, asset-backed funding plan, providing greater security for pensioners, but also reducing our cash contribution and reducing the risk of trapped excess cash in the steam. We're contracted to contribute, on average, GBP 75 million a year, so it's been down from GBP 424 million.

Cash flow remains strong and in line with our expectations and as I said, as usual, in the first half, working capital benefits from some phasing, which we expect to reverse over the second half, and we continue to plan to reduce net debt by at least GBP 300 million.

Following the introduction of IFRS 16. Going forward, we'll talk to you about 2 debt numbers. We'll talk about total debt, and we'll talk about net debt, excluding lease liabilities.

Net debt, excluding these liabilities (inaudible) and to bondholders and to banks.

On this slide, you can see how net debt, excluding liabilities, reduced from GBP 2.1 billion at March '16 to GBP 1.5 billion at March '19. And as you know, we upgraded our net debts reduction targets in September, committing to reduce net debt by a further GBP 750 million by March '22, which will increase our financial strength and flexibility.

On the subject of dividends, we've changed our policy to offset the dilutive impact that IFRS 16 had on earnings. Now obviously, IFRS 16 has no impact on our cash generation. So by changing our full year dividend cover from 2x to 1.9x, we will pay the same dividend as we would have paid, pre-IFRS 16.

For the first half, we've maintained the same policy of paying out 30% of last year's full year dividend.

So summing up, we were pleased by the improving sales momentum across all divisions over the course of a challenging half. Profits were down in the period, as we highlighted in September, driven by a number of factors that we expect to reverse in the second half as we annualized last year's 15% colleague wage increase and marketing costs and weather comparators normalize.

As discussed, the reported results were impacted by proxy-related write-downs and finally, cash generation remains strong, and we remain on track to deliver significant net debt reductions this year and over the medium term.

I'll now hand you over to Mike.

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [2]

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Good morning, and it's fair to say what I'm going to cover this morning is largely a repeat of what we've talked about in Southampton at the Capital Markets Day, so I apologize for that in advance. You've probably heard most, if not all, of the presentation already. There are a few extra data points which hopefully will give you some belief and some understanding on how we see a continuation in the improvement of our overall performance. And actually, we're very pleased with the progress we've made to date against the plan that we originally talked about in May and subsequently, the plan that we update you on in September.

So the reality is our market remains challenging, whether it's the growth of the discounters, and there's no sign that they won't continue to open stores, roughly 100 stores between the two of them going forward. And indeed, that doesn't include people like [home bulkers] and B&M bargains. The rise of digitization in our industry, and you can see that having a real impact on the number of competitors at a market where there is low or no growth. And if anything, the political backstop has probably got more challenging and, therefore, that impact on our customers' sentiment will continue unless and until there is some resolution of the current political environment. So those factors continue to weigh heavily on our industry, and you can see that impact almost day-by-day in the news flow.

However, against that backdrop, we have confidence in our core. And ultimately, we believe the core of our organization can deliver strong cash flow, accrete earnings over time, and we laid out the plans in September as to how we think we can achieve that. But above and beyond that, we think there are some real opportunities in the way that we integrate our customers up in a way that we bring our organizations together and the way we invest in some quite new and exciting areas in the future.

Our ambition is to create a multi-channel, multi-brand business. And we're well on the way to doing that and some of the things that we demonstrated in September should give you some confidence that we're bringing a number of digital assets and our physical assets together.

If we do that, we'll maintain a strong cash flow. We're able to see our way to significantly reducing our costs. And if we've got strong cash flow we can continue to invest the kind of capital numbers that we think we need in our business. We can pay down our debt, and we can pay a dividend.

And ultimately, as Kevin already said, that gives us a financially stable business that has the resilience to cope with whatever the political backdrop is and whatever the market pose -- sorry as it is for foreseeable future.

And our overall core purpose is to help our customers live well for less, wherever they choose to shop with us. And we set out 6 priorities at the Capital Markets Day: Firstly, to be more competitive on price, and we've made a lot of progress in that area; secondly, to offer distinctive products and new categories certainly to make shopping more convenient and support that with great service in our shops; to drive efficiencies so that we can invest back in our customer, and then we think there are some opportunities which are unique to us in that sphere; to grow connected services, that's particularly financial services and the role of Nectar in our organization; and last, by no means least, to continue to offer a seamless customer experience and to join our physical and digital real estate together more closely.

So talking specifically about price. We showed you this chart on the -- at least one the left-hand side, and some of the work we've been doing with the meat, fish and poultry. In the end, one of our challenges that we identified in the May presentation, was that we are losing market share in entry-price-point products, and that was the biggest source of loss in our business. So we set us out introducing new entry-price-point products.

We have a program of around 250, 260. We've already got 120 in our business, and we'll get to something like 200 by the end of the financial year. But if you look at the chart, within the meat category, the challenge we have is to restore the volume losses that we are seeing going to other of our competitors in specific categories, but not to do it in a way where our customers existing in our business actually downgrade. And as we can demonstrate through work we've been doing, as long as the purple bars become the orange bar we're winning more than we're losing and that's the important part of the way we think about this. And you can see in the meat category, as an example, that trend had continued. I think there is another 4 or 5 basis points relative to where we were in September.

And again, another case study would be the base category where we've reengineered the ranges. We've relaunched our Taste the Difference range. We've introduced a number of new products within the mid tier and we've also introduced Daily's in the form of an entry price point and new brands to our business. And again, we can demonstrate that we see sales increase and a volume increase.

We've been really pleased with our volume share. If you look at our volume share underlying, we're pretty much maintaining our volume share in the industry, which, given the impact that we have on the discounts, it's a pretty significant turnaround in the performance since beginning of the year. So we're really seeing progress on that.

Also made a number of price investments in key volume lines, in key commodities. And again, you can see the change in volume related to that. We've highlighted a number of examples, chicken wings, up 12% volume; chestnut mushrooms another key line, up 45%, white pittas bread, up 15%. And again, we've seen our suppliers coming towards this branded supplies in helping us improve our value overall. And again, that's reflected in the underlying performance of the business. And we're expressing that through the price lockdown mechanics that we see increasingly used in our stores.

And despite what you might read, we are less dependent on promotions relative to our competitors. If you look at the promotional participation in our organization. It remains lower than the market and for all intents and purposes, it hasn't changed year-on-year. And we believe it's important for business to maintain about this level of promotions because although we recognize that, from a customer point of view, it creates excitement and difference in units in our stores. From a supply chain point of view, it's not the most efficient ways of running our business and therefore, keeping that cap on the level of promotional content is important to make sure that our business runs in a cost-effective and efficient way. But you can see that relatively speaking, our spend on deal hasn't actually changed that much year-on-year and it is significantly below a couple of our mainstream competitors.

We also showed you this chart in Southampton. On the right-hand side, you can see that, relatively speaking, our price position to our mainstream competitor and by extension our other mainstream competitors has -- is as good as it's ever been. And you can see that our pricing relative to the discount, it has also improved pretty dramatically during the course at the half.

Now, we would recognize there's work to do on both of those dimensions. But nevertheless, we are pleased with the progress that we have made.

If you look at the left-hand chart as you look at the screen. That has the data in a slightly different way, which shows the relative value of items sold in our business compared with our mainstream competitors. And again, that would demonstrate that the pricing experienced by our customers in the items that they buy, week-in and week-out, which has significantly improved relative to our other big competitors. So you can see that effectively, in terms of price of items sold, we're in a deflationary cycle whereas our competitors are still, relatively speaking, inflating their price.

So again, we're pleased, and that's another proof point that demonstrates why our customers are experiencing better value than they would have been at the beginning of the half.

We talked to the Capital Markets Day about the need to think about a balanced portfolio. You can see on the left-hand chart, the position at the beginning of the year, where we were losing undoubtedly value and volume, the entry level part of our business. That's one of the issues that we set out to address. And as we said already, we made a lot of progress. We would like the chart on the right-hand side to be more balanced. You can see that we've made progress on entry price points, but still work to be done. We're roughly about half of the way through the program. So you'd expect that to improve over time. But we're not in the business of deliberately downtrading in our organization, and that's something that we have to be very mindful of as we introduce entry price point lines.

Equal at the other end of the spectrum, our customers do give us permission to trade up from their point of view. And you can see that within the premium tiers of our business, we overtrade quite significantly relative to the rest of our mainstream competition, and we've continued to push very hard on that with the introduction of 350 new products within our taste of different ranges, and we continue to see outperformance particularly in added value food categories like ready meals.

So we're very pleased with our premium and enabled products and it plays to the fact that on balance, our customers are more affluent. And that's at least in part because of the geography of our stores.

We've also worked on a program of distinctive brands. So this is where we offer the opportunity to new and innovative companies in our business. And actually, that reflects itself in our branded share. So it's not reflected as a known-label contribution to sales. So that's one of the reasons why we've tended to see our branded business grow over the last period of time. And actually, it's a pretty substantial business now at GBP 100 million of sales. They are incremental, 57% of our customers buying into one or some of our distinctive brands. We've introduced 37 new brands in the first half across fresh foods and grocery.

And an example of that was the introduction, most recently, of Leon products, where we've got a 3-year exclusive partnership, and we've introduced 14 products across around 600 of our stores, and we'll see how that goes. But you can see how that creates some form of exclusive -- exclusivity at that end of the market within the business.

Again, it's not just about the products that we sell, it's also about some of the areas where we think there are opportunities within categories. We talked about beauty. We have roughly a 3% market share. Our customers give us permission to play in that category. With the demise of a number of large department stores, it's an area where suppliers are more prepared to come to us to sell their products in our business, particularly the big branded suppliers. And we already rolled out our beauty concept into 60 of our stores. Our customer numbers up 7%; spend per customer, up 25%, and we've roughly doubled the range of beauty products in those stores.

Now there are plenty of other categories. So we talked about wellness as being another example of a category where we think there is an opportunity, pet similarly, we think there is an opportunity. So we're already trialing a number of other opportunities as we look forward that we might, at some point in the future, rollout further into our business.

We haven't talked about our CSR credentials for a while, but we made a very significant commitment during the course of the half to reduce the amount of plastics in our business by a country mile. It is the single biggest reason that customers contact us and contact me. It's one of the big topics on their minds, the biggest topic on their minds. And so it's a very significant commitment to reduce the impact of plastics by 50% by 2025. And we've already made a couple of big steps on that journey, removing plastic bags from our online delivery service and replacing single-use bags in our produce departments with reusable bags, both which have landed extremely well with our customers. So, very pleased with the progress, but lots of work has to be done in that area.

Within Argos, we've made a number of steps to improve our availability. So we have been through a big program of rationalization. So we've reduced our master assortment by about 30% over the last 3 years which has eliminated a lot of duplication. The Argos model ultimately is predicated on the cash profit per item sold, and that's a very important factor in the way that we think about how we engineer our ranges for the future. And what it has allowed us to do is to significantly improve product availability in our stores. So your likelihood of finding the item that you want to buy with any given shop or any given geography has improved markedly over the last 3 years.

And we're also rebalancing the ranges into the higher-margin categories. And that's the case not just in Argos, but also in the supermarket chain. A good example of that would be entertainment where, broadly speaking, the market is moving very rapidly away from DVDs. It's actually, relatively speaking, a reasonably high sales market. But actually a relatively low-margin market. And over time, we would gain share and are gaining share in our categories like furniture, like Home, obviously the Clothing business. And that, again, represents an opportunity, which we are beginning to see significant progress on in the last half.

We've also introduced a new advertising campaign, which is highlighting some of the design credentials of the products that we sell, not just within Sainsbury's supermarkets, but also within Argos.

Pricing continues to be a success story. Now largely, although not exclusively driven by online. So online clothing now represents around 8% of our business. That was nothing a few years ago. We're continuing to invest in that proposition. So, Tu online, its sales are up about 52%, albeit from a relatively low base, but nevertheless, very pleasing progress. We have 800,000 new customers in the online space, and that's up 31% year-on-year.

We've done a good job of managing our markdown and our margin mix during the course of the half. And again, we've introduced a new advertising campaign for everyday use of our clothing as we look to extend the franchise.

But we're very pleased with our clothing performance overall and it continues to be a driver of growth and we expect it to be into the future.

If we look at our making our shopping more convenient, or making our shops more convenient, let's start with our supermarkets. Again, we talked about the fact that we need to repurpose a lot of our space. And we've already repurposed about 870,000 square feet since 4 years ago. Increasingly, we are tailoring our investments, which Graham talked to you during the Capital Markets Day and the way that we think about our stores. And we've significantly stepped up the investments in our -- capital in our conventional supermarkets. So we will invest in 450 supermarkets, of which we've already covered 172 in the first half. There are something like 40 currently going through something of investment in this current quarter. But we'll get through roughly 450 supermarkets investments during the course of the financial year.

And then we would point to the fact that our trading intensity, largely, although not exclusively as a results of Argos stores in Sainsbury's stores has progressively improved over the last 2 years, which is one of the key drivers of the economics of the supermarket.

Where we've made [policy] investments, we have seen that reflected in our customer metrics. So we talked about the [fast] lessons and more on how we can measure our service metrics literally by store, by department, by day, and give our stores real-time feedback. But it also highlights the macro areas where we can do better. So with the combination of the investment in SmartShop now in roughly 350 shops and the upgrade in our self- checkout, we've seen a marked improvement in either check out and check out speed in the way that our customers look at our business, and that's very marked in the stores where we've made the changes.

And through the technology we've invested in through our focus on customer services we improved our availability metrics, and we've seen our CSAT score overall year-on-year, improve by around 3 percentage points. And we continue to invest in the core fabric of our supermarket. So things like making sure that our toilets are up to scratch, our car parts are well lined and well laid out and the fabric of the building is properly invested. And again that's a big part of our program into the future.

And when we make these changes, we do see it reflected in the customer statistics so we know that there is a cause and effect that where we make changes, our customers recognize it, and that would make them more likely to shop in our shops in the future.

Convenience, as I said before, it's a fantastic business for us. Another half of growth. It was a little bit damped in the early part of the year. So that's certainly reflected in the numbers. If you look at the second quarter performance. It was strong, very strong, and we continue to look at every opportunity in the convenience space that we can, and we talked about the program stores that we've got going forward. Again, in terms of our investment program, we'll touch around about 200 convenience stores during the course of the year. So we reached about 158 stores in the first half.

And then as we talked before, one of the things that we've done with our convenience stores is to get much more tailored range, such that only about 15% of the range is common to all stores and by definition 85% is somehow different on a store by store basis. So much more focused on tailoring the ranges. And individual SKU choice makes a huge difference when you are only carrying, let's say, 3000 SKUs in a shop. So it's important that we tune that and continue to tune that into the foreseeable future.

And again, a big part of our program in terms of checkout investment, particularly self-checkout, so it's gone into our Convenience shops where speed and ease of shop is even more important than it is in a supermarket. Environment and, again, we've seen the stats within the speed and ease in checkout move forward very significant year-over-year. And there isn't a single measure within our Convenience business on customer satisfaction that hasn't moved forward markedly in the last couple of years.

Again, Groceries Online, I mean, it's remarkable how consistent the growth is. Now accounting for roughly 8% of our grocery sales. But Grocery every year, for the last 5 years, we've seen a 7% increase in the sales. As Kevin told you, we actually had a relatively stronger performance in the second quarter compared to the first quarter, and we now have same-day delivery in 60% of U.K. postcodes. The growth here remains at -- account to roughly 20% of the orders. So again, the penetration of the online app is increasing month-by-month. We've extended delivery slots, so you should get more availability in terms of delivery slots than ever. As I said already in the CRS agenda, we've introduced bagless deliveries. And we can certainly see our way forward in terms of the capacity for growth within our existing real estate for the foreseeable future so we continue to invest in adding capacity within our existing physical real estate as in our stores rather than through (inaudible) stores.

Argos, again, if you look at the shape of the business, and that's the way it's changed during our period of ownership, the number of walk-in customers has dropped 7% as a proportion of sales. We've seen fast track growth in 15% to 24%. And again, something like 64% of the business is now transacted online either through delivery to the home or through some kind of click and collect process.

So we have pretty much got through the digitization of all of the Argos real estate. So I got rid of all of the Fisher-Price toy keyboards that you'll all be or some of you at least will be familiar with. So the vast majority of shops will have a digital offer, fast track payment, pay up browse payments so that you don't have to go to a checkout, which enables our colleagues to more obviously interact with our customers and not be stuck behind a checkout. So you can see that program of change accelerating during the course of this year.

Again, we talked in Southampton about how we think about reducing costs in our business. And our single biggest cost is our cost of goods. As Paul articulated, we think we're pretty good at what we call value chain analysis, which is looking at the value chains that suppliers are looking for leakage of value and finding out ways or working on ways with our suppliers as to how to reduce our cost of goods by eliminating that leakage.

Equally, when we review categories, we look at how we can make our ranges more efficient, generally speaking, by reducing SKU counts. That allows us to increase the velocity of lines, the volume intensity and therefore, that has an effect on the productivity in our business, but also in our suppliers. That enables us to improve our relative value. It allows us to offer more distinctive ranges where appropriate. And overall, that allows us to drive a higher cash profit.

Now we've engineered roughly half of the categories in our business by looking at our PQF. And it is a continuous journey. It is a bit like painting the Forth Road Bridge, when you finish the program and you go back to the beginning and start again. But we still think we've got about half of our ranges to address when we look at the overall food volume in our business.

And if you look at the cereals range, it's a case study on the outcomes of this process. So we've reduced our SKU count by about 20%. We have more distinctive ranges so particularly with some of our distinctive brands as an example. We've been able to generate money so that we can reduce our prices and improve our value index.

As a result of the work that we've done, we've seen our volumes go up, but we've also seen our cash profit go up as well. So again, that's an example of where our overall ambition is to grow our volumes and to at least cover the cash profit and to grow that overall when we look at our category development.

Again, we talked about our cost savings program with 2 elements. One is a sort of pay to play. You would expect anybody in our sector to look at its cost base and roughly cover the cost of inflation. And we do that. We've got a pretty good track record in all of the areas that we have underlying cost pressures, whether that's goods not for resale, whether it's investment in retail technologies, whether it's reduction of our shrink costs. We've got some quite interesting technology in that space. We've dramatically improved our retail HR systems, which allow us to be more efficient. And clearly, during the course of the year, in both of our businesses, we've significantly streamlined our retail management structure. So that's kind of very much the pay to play.

But we also believe by integrating our businesses more closely together, first of all, the way that we show up to our customers will be more coordinated. But secondly, there are lots of opportunities to make structural and unique cost savings within our organization. I gave the example at the CMD, we have 12 data centers. If we look at our business overall, we probably don't need 12 data centers. We probably need half that number. And that's just scratching the surface in terms of some of the efficiencies we can bring to bear.

And we talked about making GBP 500 million worth of cost savings above and beyond the pay to play of covering cost inflation during the course of the next 5 years. And with the work that we've done, particularly in the last couple of months, we've got better and better line of sight as to how we can deliver that. And we gave some summaries on the chart as to where we think the main areas of opportunity and improvement are, but a very significant cost transformation program.

And as we said in September, we believe some benefits, which are unique to us. In terms of things that we can do that give us belief that we can grow our earnings above and beyond the core business, we talked about Financial services. And Jim laid out a plan for how we will double our UPBT, reduce the impact as in -- for the supermarket, the group as a whole, put less cash in, in fact, no cash in and to provide a more agile offer to our Sainsbury's own Argos customers.

So having laid out the plan in September. We're now getting on and executing that. And the shape of the organization looking forward will be more orientated towards customers -- products which connect with customers in Sainsbury's and Argos. Argos store cards being a good example of that.

In the commission-based products, such as insurance, ATMs, travel money, but as we announced in September, we've stopped writing mortgages and we're reviewing what we'll do with the mortgage book in the future.

So in financial terms, that means we don't need to put any more cash in. We will double the profits of the bank over the next 5 years. The bank will generate cash. So at some point in the future, there will be the opportunity of repatriating money back to the group overall. And we've an ambition to reduce our cost-to-income ratio to 50%, and we can see now our line of sight as to how we will do that. We've stopped mortgage acquisition where we will review our options as far as the mortgage back book is concerned. And ultimately, our ambition is to drive value within the group because we know that if a customer has a financial services product, they will be more loyal to the company overall. And the more that we can put those financial services into the checkout flow of our customers, the more penetration that we think we can drive within the financial services business.

Somebody just switched my microphone on for the first time. I've just got louder, anyway. Nectar, we talked about the introduction of Digital Nectar, which was very much on the blocks at the time at the Capital Markets Day. We've now launched it, and it's been incredibly successful. So very pleased with the fact that we now have 2.1 million customers using Digital Nectar, and it's one of the things that's at the heart of our strategy of connecting our customers together, both in terms of the brands that we offer, but also between our physical and digital real estate. And of course, the digital channel gives us the opportunity of talking to our customers in real-time, wherever and wherever they want and we want.

So Nectar is the biggest loyalty scheme in the U.K. We have 80 million collectors. It's the most recognized loyalty scheme. And as I said, we are really pleased with the launch of Digital Nectar, and at one point, it was the -- I keep being corrected -- I think -- it was the most downloaded app in the U.K. for at least a weekend, which would put it at the top of the charts. So pleased with that.

But in addition, we want to build a broader coalition. So the power of Nectar is not just within the group. Again, if you think about it, Nectar points are currency. They have an exchange value. And the more Nectar points we can put into the ecosystem overall, the more Sainsbury's as a company will benefit from that. And we've added SO as a partner, as one example during the course of the half. But equally, we would want to broaden that coalition over the next period of time.

And I won't do justice to the presentation that Clo gave at the Capital Markets Day. I've only got one slide. But looking forward, we're doing some really, really exciting stuff in the world of digital. So whether that's the Nectar app, now in the hands of 2.1 million customers; whether it's the Argos Financial Services app, now in the hands of 1.4 million customers; whether it's Smart Shop in the stores that we are operating, the penetration of sales is roughly 15%; in the highest penetration stores, it's pushing towards 25%. And increasingly, we are looking to join together our digital real estate so that you, as a customer, would have a seamless experience. And increasingly, we can join our proposition, our offer together in ways that chart to our customers to satisfy their very immediate needs across a whole broad spectrum of products and services that we sell.

So we're well on the journey. There's lots of exciting stuff coming down the road. I won't do all the demonstrations that we gave at the Capital Markets Day. But you can see that we've made even in the last 5 or 6 weeks significant progress along that road.

So in summary, we're confident in our core. If anything, what's happened between September and now has given even more confidence that we've maintained our relative volume performance, and we've got line of sight to deliver against the things that we set out to deliver, whether that's entry price points, whether it's improving our value, whether it's increasing our efficiencies or the reengineering of the bankers, some examples. We believe that there's lots of upside in our integrated customer offer. And therefore, not only can we underpin the earnings of the company, we think there's plenty of potential for growth in the future.

We are creating what we believe to be a unique multichannel, multi-brand organization. We will continue to make sustainable cost reductions, which will enable us to remain competitive and invest in our overall customer offer as well as covering the cost of inflation. Ultimately, that leads to strong cash generation. We can invest in our shops and our digital real estate. We can pay a dividend, and we can pay down GBP 750 million of the debt over the next 3 years.

And ultimately, that also gives us a lot of financial resilience and flexibility in what is not -- to say the least challenging market and challenging environment.

So we're confident in our future. So that's it for me. And we will now go for -- oh, sorry, I'm now going to play you the 2 Christmas ads just by the way of a bit of seasonal likeness. So I will step down, and Kevin and I will then answer questions.

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Questions and Answers

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [1]

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Go on, Bruno, you put your hand up first.

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Bruno Monteyne, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [2]

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Bruno Monteyne from Bernstein. Mike, on the profit guidance for the second half. There's a material shift into the second half that should be better. And I think 2 out of the 3 reasons you quote are weather and change in marketing shift. Now my question is twofold. So is it really 2/3 of that improvement depending on that? And how much confidence do you have, given that counting on British weather seems risky? And obviously, we know that Tesco's launching Clubcard Plus and other activities. It might actually require quite a step-up of marketing commercial activity. So how much confidence and how much of it really depends on the less marketing and better weather in the second half?

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [3]

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I defer to my colleague on the right.

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Kevin O'Byrne, J Sainsbury plc - CFO, Member of the Operating Board & Director [4]

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Well, I mean, there's 3 factors, Bruno, because it's also the phasing of cost savings. And there's one material effect there is what's too simple to just point to one because there's lots of moving parts is that we don't need to have a wait. We had the wage increase in September '18. So we don't have a wage increase in the second half because it was in the second half last year. So that's a big factor. The marketing is a big factor. And I wouldn't overstate the weather in this we're just saying we were expecting normal weather. We didn't have normal weather. We're kind of assuming normal weather. Clearly, if we get ridiculously different weather, then we'll talk about it later, but we're not expecting it.

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Bruno Monteyne, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [5]

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Because -- so you're feeling quite highly confident that this step up, H1 to H2. What's your...

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Kevin O'Byrne, J Sainsbury plc - CFO, Member of the Operating Board & Director [6]

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We're feeling confident in our plans, as you always, they come with some caveats as you're facing into pre-Christmas trading, as always. But our plans are good. Our products are good. We've got -- if you think about what we said we'd do in the first half, we said we'd lower prices, we've lowered prices. We're in a great position from a price point of view. We've launched our value brands 123, 200 by the year-end. We've improved our service, our CSAT scores were up 3 percentage points in the half. We're investing in the stores, in our produce areas, in our bakery areas. So we're in a good position going into Christmas trading.

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Bruno Monteyne, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [7]

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And do you see any probability that you'll be forced into a response to Clubcard Plus in the run-up to Christmas? Or you think this is not a major event in the overall bigger scheme of things?

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [8]

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Yes. You probably know more about that than we do. But we have a set of plans, we'll get on and execute our plans. There are a whole bunch of things that we're doing in that space. We talked about Nectar and Digital Nectar. I mean that's our version, if you want to put that way around of Clubcard Plus. As Kevin's already said, at this point in the cycle, we're 7, 8 weeks away from Christmas.

So lots of things could happen between now and January 4, when we'll dust ourselves down and how -- we'll see how we've done overall. But we're very confident in our plans and all of the volume trends that we saw in the second quarter have remained pretty stable if you look at the Kantar data. So we're pleased with the performance, and it would demonstrate that you don't need some of the headline marketing activity to generate the kind of volumes that we need to generate.

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Robert Joyce, Goldman Sachs Group Inc., Research Division - Equity Analyst [9]

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Rob Joyce, Goldman Sachs. A couple more from me. Similar theme, actually. So we look at the sort of headline market share data year-to-date. We've seen a very material improvement for you guys from maybe minus 40 bps to flat into September and then back down to sort of minus 35 bps in October. Just wondering if it's not promotional cadence, what's really explaining that kind of volatility? And what would be a good sort of consistent number we should hope for you guys to achieve from here?

And the second one, if you look at your price chart versus Aldi, clearly, a material improvement this year. But at the beginning of the year, it looks like Aldi improved their price versus you very materially as well. Is your guidance -- I mean, was that then pushing hard on prices? And is your guidance assuming a similar step-up in price competition in the early half of 2020?

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [10]

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You and I will always differ on unit.

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Kevin O'Byrne, J Sainsbury plc - CFO, Member of the Operating Board & Director [11]

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Yes. So Tesco are running the 100th anniversary campaign for the particular period of time that you're talking about. But if you look at the 12-week data, which is a more realistic read of the underlying performance, you can see that our volume share is actually pretty stable year-on-year and we see some other data that you don't see, which will give us confidence that, that's the case.

We said that what would be our measure of success will be to at least maintain our volume share versus the market, ex the discounters. If you look at our current performance, it's better than that. So that's why we have confidence as we go into the busy Christmas trading period.

And the other observation, which hopefully comes out from the presentation, is in the changes that we're making. We're probably only about halfway through the introduction of entry price points, the reengineering of ranges, the investment in the store program. And even if you look at the store program, there is an element of disruption that goes on as and when we touch each one of our stores. So against the backdrop of the market and against the objectives that we set out, we're very pleased with the progress that we've made.

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [12]

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Rob, it's probably also worth understanding this. If you look at the 4-week data and compare it to the (technical difficulty) quarter 1 of this year and quarter 4 of last year, it's still an improvement on that (technical difficulty) obvious, the change is clearly week by week.

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Kevin O'Byrne, J Sainsbury plc - CFO, Member of the Operating Board & Director [13]

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And I'd have to go back to the charts and just to understand exactly the point you're making, the point we would make is that, relatively speaking, with the instruction of the entry price point lines and some of the price investments we've made, we've seen 800 bp improvement in our relative price position to Aldi. Now I'm sure before that, it would have gone up and down. And so I have to pick through the data just to work out exactly how much.

But the most important thing is that step has been very marked in the half that we've just gone through, and we would still recognize there is work to be done and we're on with that.

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Robert Joyce, Goldman Sachs Group Inc., Research Division - Equity Analyst [14]

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Are you seeing a competitor response at all?

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Kevin O'Byrne, J Sainsbury plc - CFO, Member of the Operating Board & Director [15]

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It's the blood and guts of normal trading. And we watch, as you -- I'm sure you're fully aware how our competitors respond. But if you take the -- or both of the price gaps, we've maintained the improvements that we made earlier in the year.

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Andrew Philip Gwynn, Exane BNP Paribas, Research Division - Senior Food Researcher & Analyst of Food Retail [16]

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So it's Andrew Gwynn from Exane. I'm going for 3 questions, be a bit greedy. So the first question, just on the charts you showed before around this switching on the value brands. I think that's sales data. But could you just provide a comment on the gross profit impact? Obviously, the down-trading into potentially lower volume categories could be a bit more significant.

The second one, you mentioned before about the market being maybe a bit more challenging in light of sort of politics and whatnot. So I was just wondering if you could elaborate a little bit on that particularly in the context of the better volume performance you're seeing.

And then the third one, just on the Argos management integration, obviously, with the departure of John Rogers, you're essentially rolling that management role into the group. Can you just comment a little bit more on the logic of that? I mean, it strikes me, obviously the dynamics of the 2 businesses are still relatively different, and I appreciate it's better integrated than it was. It's still a very different sort of business.

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [17]

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Yes. I mean, we obviously don't comment on gross margins, but we try to give you some sense of what we're trying to achieve, which is broadly speaking, to grow our volumes and at least maintain our cash profit. The case studies that we have showed you would demonstrate that, broadly speaking, we have achieved that in many cases, we're actually growing our gross -- our cash profits not necessarily at the same rate that we're growing the volume.*

But overall, if you can sell more stuff and make at least as much money, that's where we would set our ambition. If we can get ahead of that, which, generally speaking, we are, then that's a great place to be. Markets -- well your guess is good as mine what effect an election will have on how customers are thinking and feeling. My own view is that almost regardless of what's going on in the world of politics and the economy, people will have a good Christmas, they will trade up either through the supermarket brands or within the supermarket brands.

But the quicker we can get to some kind of end point, the more likely it is, I think our customers will feel more confident about spending their money. We've observed before that if you look at net disposable income, it's actually going up. So customers have more money in their pocket, but that's not being reflected in retail sales, which is normally where they'd spend some of that money. So depending on where we get to with the political resolution, you could have some belief if we get to political resolution that customer sentiment might move upwards.

When you look at the latest GFK data, it's gone backwards yet another step and customer sentiment is back to where it was after the financial crash. And we've always had the journey on as far as Argos management integration of bringing the organization together to the point about the significant savings we can make across the business, whether that's data centers, call centers, logistics, management overhead. And the way that we increasingly join our businesses together from a customer point of view, we can only do that by integrating the businesses more closely together. And there are a whole range of opportunities in the way that we do that.

Equally, we'd be the first to recognize there are some unique things about the Argos brand, and it's important that we maintain those as we go through that integration journey. But ultimately, if we have the ambition of being able to sell any product anywhere, we have to have a more integrated logistics function as an example than we have today.

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Nick Coulter, Citigroup Inc, Research Division - Director [18]

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Nick Coulter from Citi. Just on Argos. You spoke about managing the mix. But have you adapted your approach into peak given the volatility that you're experiencing with the consumer? I guess I'm just trying to seek some sort of reassurance with respect to Argos across what will be a pivotal trading period with that consumer backdrop in mind. And then just secondly quickly on the exceptionals in the first half. Is it possible to have a cash figure for the hit, please?

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [19]

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I'll ask Kevin to respond on the second one. I'm a bit like you. I've got my fingers crossed at the moment. I mean, we have planned for peak. We've got great plans in place. We have all the resilience that we need built into the system, and that really kicks off over the next 5 or 6 weeks. So it's very, very early in the season.

But ultimately, we are set up as well set up as we've ever been to deal with whatever comes our way as far as the Christmas trading period is concerned. Equally, the jury's out, there are a whole bunch of things that could get in the way of Christmas, they -- but generally speaking, our experience is that people will behave in the same way that they behaved historically.

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Nick Coulter, Citigroup Inc, Research Division - Director [20]

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When you say resilience, could you give some practical examples?

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [21]

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Or just making sure we're up to -- as an example, Black Friday is a big peak. The maximum number of transactions that ever go through the Argos system happen on Black Friday, making sure that all your systems are in place to be able to deal with that peak would be a good example, that you've got the people in the shops there to take the money from our customers when they buy the products that they need to buy, et cetera, et cetera. So all that planning is going on in the background to make sure that we're as well set up as we can possibly be.

We've also made, as we've already described, a number of significant improvements in the overall offer, availability, pricing, ranging quality, which would stand us in good stead overall, not just within Argos, but within the business more generally.

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Nick Coulter, Citigroup Inc, Research Division - Director [22]

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But you're running with broadly the same levels of inventory into peak?

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [23]

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Yes. I mean, without going into the detail, we're planning for a successful Christmas. That's what we always do, like any general merchandise and clothing business, you always don't have enough of what you can sell and you always have too much of what you can't sell, and that's part of managing the season, and we're as well equipped as ever to make sure that we deal with that. .

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Kevin O'Byrne, J Sainsbury plc - CFO, Member of the Operating Board & Director [24]

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On the -- and actually, in the first half, it was actually cash positive, but it's a minimis number because where we sold some properties we had a property gain, and that's offset and we haven't actually incurred a lot of the cash costs for the property decisions.

But we said in September, there's -- the total would be something in the region up from a P&L point of view, 230 to 270 with GBP 30 million to GBP 40 million of cash because it's largely asset write-downs is there's clearly redundancies in there. And the other item that was on there about Argos, will be some redundancies in that number. But I'll just bring you back to the number, we're managing to less than GBP 100 million of cash this year. But in reality, some of that will be decisions we made last year, where the cash went out this year. Some of the decisions this year, the cash will go out next year, but we're managing to that GBP 100 million cash out this year.

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Nick Coulter, Citigroup Inc, Research Division - Director [25]

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So I guess the question is, what's the cash outflow in the second half then? Broadly, so you've already got something coming in, in the first half. So what's the...

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Kevin O'Byrne, J Sainsbury plc - CFO, Member of the Operating Board & Director [26]

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Well, the total, the full year will be GBP 100 million. That's -- we're not breaking it down anymore, yes.

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Clive W. Black, Shore Capital Group Ltd., Research Division - Head of Research [27]

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Clive Black from Shore Capital. I was interested in your comments, Mike, about the discounters, and you also touched on the bargain stores. Stepping back from results as an industry statesman, how would you see the -- you're almost, well, you're slightly older than me actually. Within the context of your experience, how would you characterize the German discounters and the bargain stores versus Sainsbury's today to the extent of do they still represent the same form of challenge as against the last decade? Or are you through the sort of peak of their challenge? Or indeed, are you on the other side of a peak?

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [28]

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As of today, there's no evidence that they are slowing down their rate of store development and no matter how brilliant a retailer you are, if whatever, 600,000 square foot of space lands on your doorstep, one way or another, that's going to impact your business. So as far as we can see for the next 3 years, that rate of store development will continue.

We would argue, as you've heard us argue on numerous occasions, you've got businesses which are making a lot less money than they were 3 or 4 years ago, but continue to invest vast amounts of capital and at some point, you have to believe that, that becomes increasingly non-returning. I would argue already, it's non-returning, but let's assume at some point even the most irrational business person would have to take a choice that they would slow down that capital investment. But there's no sign that, that's going to happen.

I mean, for us, the bargain stores are less of an impact. We don't see it as much, but it clearly has an impact on our competitors, and that reads through in market pricing in particular. But of course, as they grow, they start to have the growing pains of shopping insurgence and starting to be more stable businesses that continue to supply relationships with their suppliers become more mature and therefore, the way they run their business has to evolve over time.

And the other charge that often gets laid at our door is somehow the discounters are going to invade the Southeast of England and London. We look at this every time we get asked the question, and there is no evidence to support that thesis. There's evidence that they're filling the pot roughly at the same speed everywhere across the U.K. That does mean that they're opening shops in London and the Southeast, but that's not disproportionate to where else they're opening shops.

So again, we would argue that our real estate in the round is on balance, more protected from the potential threat of the discounters than some of our mainstream competitors largely because our geography is very Southeastern London Centric.

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Xavier Le Mené, BofA Merrill Lynch, Research Division - Head of European Food Retail Equity Research and Director [29]

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Xavier Le Mene from Bank of America. Two quick ones, if I may. Can you give us a bit more detail about the product quality framework? So you achieved 49% going to 51%. So what is the timeframe here? So when do you plan to achieve everything? And how does it fit with the change of all your entry price products? So how do you -- that things altogether? And lastly, what is the volumes expectation you can get you when everything would be done?

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [30]

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The third one, I'm not going to speculate other than go back what I said earlier. In terms of our minimum bench markets, it's to maintain our share of the market ex the discounters. Actually, if you look at how we're doing currently, we're doing better than that. And if we can sustain that level of performance, then that will be a good outcome from our perspective. I'm looking at Paul in terms of the PQF. He's looking at his phone, so he's not even listening to the question.

So 49% through when we will be through the whole program.

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Paul Mills-Hicks, J Sainsbury plc - Food Commercial Director & Member of the Operating Board [31]

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We did about 11% in...

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [32]

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Two years.

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Paul Mills-Hicks, J Sainsbury plc - Food Commercial Director & Member of the Operating Board [33]

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We about 11% in the half.

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Michael Andrew Coupe, J Sainsbury plc - CEO, Chairman of the Operating Board & Executive Director [34]

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And then on entry price points, we said we'd get 90% of the range out by the end of the financial year. So there's some products around the edges, but it effectively means out of the 280 or so products we'll be to sort of 240, 250.

But as I said during the course of my presentation, once you've done it all you then go back to the beginning to do all again. So it is a continuous loop. So another way of looking at it is it takes roughly 3 to 4 years to do a full cycle of every category. And then when you finish that cycle, you go back to the beginning and start all over again.

Any more for anymore? Don't feel you have to? Thank you very much. Have a great Christmas. And hopefully, you've all downloaded the Nectar app and the Argos app, and you'll all be doing your Christmas shopping with Sainsbury's. Thank you very much.