Smart & Final Downgraded At Morgan Stanley On 'A 2:1 Negative Risk/Reward Skew'

Food Retailers have been under pressure due to uncertainty around deflation and competition; and the pressure would likely continue through the back half of the year, Morgan Stanley’s Vincent J Sinisi said in a report. The analyst added that Smart & Final Stores Inc (NYSE: SFS) faces “outsized risk” on account of its higher leverage and lower margins than peers.

Sinisi downgraded the rating on Smart & Final to Underweight, while reducing the price target from $16.50 to $13. He added that the price target reflected 7 percent downside, with the shares having “a 2:1 negative risk/reward skew.”

Outsize Risk

Smart & Final reduced its full-year EPS guidance range, now incorporating a 22 percent decline at the midpoint. Sinisi pointed out that this reflects the risk posed by deflation for companies that have high leverage and low margins.

Despite the guidance reduction, the analyst still believes there is 5 percent downside to the consensus EPS estimate for 2017 and a 13 percent downside for 2018. He considers the Street’s margin assumptions “too optimistic.”

“Smart & Final continued to face cannibalization, largely from acquired Haggen locations in addition to 2015 SFS locations; the impact was ~230bps in 2Q,” Sinisi commented. He added that Smart & Final's exposure of more than 70 percent to California creates “growing risks related to cannibalization, wages, and competition.” The analyst stated that margin inflection appeared “increasingly uncertain.”

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