J Sainsbury plc (OTCQX:JSNSF) Q2 2022/2023 Earnings Conference Call November 3, 2022 5:00 AM ET
Company Participants
Simon Roberts – Chief Executive Officer
Kevin O’Byrne – Chief Financial Officer
Conference Call Participants
Andrew Gwynn – BNP Paribas Exane
James Anstead – Barclays
Rob Joyce – Goldman Sachs
Clive Black – Shore Capital
William Woods – Bernstein
Xavier Le Mené – Bank of America
Sreedhar Mahamkali – UBS
James Grzinic – Jeffries
Nick Coulter – Citi
Victoria Petrova – Credit Suisse
Simon Roberts
Good morning, everyone. And welcome to our 2022/2023 Interim Results Presentation. Thank you for joining us today. I will start with a brief introduction to cover progress against the priorities set out as part of our three-year plan. Kevin will then cover the first half financials and then I will go into more detail about our strategic highlights and performance delivery, at what is the halfway point in our three-year plan.
Now, you will remember that these were the priorities we set out two years ago, in November 2020. Our key value creation pillars of Food First, Brands that Deliver, and Save to Invest, underpinned by being Connected to our Customers and delivering our integrated Plan for Better.
We laid out in April the key focus areas which would underpin our performance delivery over the course of this financial year. We have been relentlessly focused on each of these and have been delivering consistently against them. As we navigate the second half of the year, it will be more of the same, with all six imperatives remaining front of mind for me and all of our team.
Now, I am encouraged by our progress so far this year and we are delivering for all our stakeholders as a result. For our customers, we are the best value we have ever been and we continue to make solid progress in the competitiveness of our offer. Of course, this is more important than ever, during such a tough time for millions of households.
We are committed to building the long-term loyalty and trust of customers throughout this period, and importantly, we have strengthened our firepower to help battle inflation, funded by a cost savings program that helps us invest more than our competitors.
For our colleagues, we continue to take a leadership position in our industry on colleague pay. We have invested £150 million this year to support colleagues and drive outstanding service. We were the first supermarket to offer a second pay rise in the year in September and we have announced additional colleague discount and food support for our teams.
For our suppliers, well, we have continued to develop and further leverage strong supplier relationships and the scale benefit from our volume share gains. Of course, we have needed to be flexible, listening and supporting our suppliers, given the challenging macroenvironment. And in turn, our suppliers have supported us and I really want to thank them for all their help and commitment and this is reflected in improved availability we are delivering for our customers.
For shareholders, well, we are committed to improving returns, by creating a simpler, more focused business. As you have seen, profits are significantly higher than before the pandemic and we are delivering strong cash generation, driving down leverage, and supporting dividend payments
This slide shows how we are delivering against our strategy for customers and colleagues. We are inflating behind the market month after month and we are the only full-choice supermarket to have grown volume market share versus pre-pandemic levels from the first half of 2019/2020, and we have grown share again year-on-year.
Now we are pleased, too, with Argos performance, particularly in quarter two, when we significantly outperformed the market, as customers were looking for value and a brand they can trust.
We continue to lead on supermarket customer satisfaction and we are encouraged that our colleague engagement scores have improved again. This is a priority for us, which I regard as no small achievement in such difficult times. Having the most engaged colleagues is absolutely at our core, in order to deliver leading customer service.
All this is made possible by the scale of our cost savings program, creating the firepower to invest in price and colleagues, ahead of our competitors. We are at the halfway point in our three-year cost saving program that will deliver £1.3 billion by the end of next year, double the run rate of the prior three years. It is important to stress that a lot of these savings are unique to us. Not least, for example, the benefit of putting Argos stores inside Sainsbury’s supermarkets.
Stronger volume performance than competitors is also creating competitive advantage. So, we are improving our competitive position and mitigating operating profit pressures, which is enabling us to deliver profits significantly ahead of pre-pandemic levels.
I will now hand over to Kevin to talk through our first half financials.
Kevin O’Byrne
Good morning, everyone, and thank you, Simon. I will now cover the financial highlights for the 28 weeks to 17th of September. I am going to start by looking at sales on a year-on-year basis. Overall, Grocery sales grew by 0.2% during the first half, despite tough comparatives. We saw sales growth strengthening in the second quarter to 3.8%, as the lockdown comparatives eased, inflation was higher and customers responded well to the strength of our offer.
We also benefited from warm summer weather, which supported sales in both Grocery and General Merchandise. General Merchandise sales declined overall across the first half, but we saw growth in the second quarter of 1.2%, with Argos sales up 1.6%. Alongside the favorable weather, this was driven by the work we have been doing to improve availability and resulted in strong market share gains. Growth was strong in particular, in consumer electronics and seasonal products.
Clothing sales were down in the first half, reflecting the impact of customers returning to the high street, as COVID restrictions eased. In the second quarter, clothing sales were broadly flat. In total, H1 retail sales, excluding fuel were down 1.3% year-on-year, including the impact of higher fuel sales, first half sales growth was 4.4%.
I also wanted to share sales comparatives versus three years ago in order to provide a pre-COVID comparison. Grocery sales were up over 9% on a three-year basis, driven by sustained higher volumes post-COVID, as well as inflation.
General Merchandise sales were down 5% versus three years ago, with Argos sales down around 3% and Sainsbury’s General Merchandise sales down nearly 15%. This partially reflects our shift in focus towards more profitable sales, including a reduction in promotional activity and a strategic decision to exit less profitable categories, such as entertainment in Sainsbury’s.
Clothing sales were 2.5% higher than three years ago. This was achieved despite a reduction in promotional activity. Full price clothing sales participation levels are significantly higher than 2019/2020, 80% this year versus 64% in the first half of 2019/2020. So, total retail sales, excluding fuel, were up 5.9%. Including fuel, first half sales were up 9.2%.
Retail operating profits in the first half were down 9% year-on-year. This reflects the investment we are making in value, the impact of reduced Grocery and General Merchandise volumes post-pandemic and higher operating costs, partially offset by a higher contribution from fuel.
Financial Services made a profit of £19 million in the first half, which is in line with last year. Underlying profit before tax was down 8% year-on-year, which represents a 43% increase versus the first half of 2019/2020. Finance costs were 9% lower, year-on-year, driven by interest income from higher cash balances and lower interest rates on new leases.
At a statutory pre-tax level, we reported a profit of £376 million. Now, this is down £151 million against the prior year, which included £181 million of exceptional income, relating to the settlement of legal disputes.
As you can see here, we delivered strong retail free cash flow in the half of £759 million, up 37% year-on-year, with a working capital inflow of £360 million. This inflow reflects higher Grocery sales in quarter two and a more typically strong seasonal working capital position seen at this point in the year, and as usual, we would expect this to unwind in the second half.
We were in a net funds position of £361 million at the end of the first half and we are pleased with this strong delivery. This is the first time we have reported net funds. We are on track to deliver at least £500 million free cash flow this year, in line with our three-year target to March 2025.
The reduction in underlying earnings per share is consistent with the decline in UPBT and we will pay a dividend of 3.9p per share, up from 3.2p per share last year, in line with our practice of paying an interim dividend of 30% of the prior year’s full dividend.
Looking now at Financial Services, where profit was flat year-on-year. Growth in revenues was firstly driven by a recovery in ATMs and Travel Money, although these areas of commission remain behind pre-pandemic levels.
We also grew interest income, as demand for credit increased, although, again, as you can see, our total credit card and loans book is over £1 billion lower than pre-pandemic levels. This growth in income was offset by higher impairments and increased costs.
Higher impairments were driven by three factors, growth in the loan book, additional provisioning made as a result of more cautious economic forecasts and the normalization of arrears levels post-COVID. Overall arrears levels remain low. Increased costs were driven by recovery of volumes and some operating cost inflation.
Going back now to the Group P&L. In order to provide a clearer view of our underlying performance, as usual we exclude P&L items, which by virtue of their size and/or their nature do not reflect the Group’s underlying performance. These are outlined on this slide.
Restructuring costs of £33 million relate to the program announced in November 2020 for the structural integration of Sainsbury’s and Argos. Our guidance for total restructuring charges for the three years to March 2024 is unchanged and we still expect a cash outflow of around £60 million this financial year in relation to this program.
Offsetting this, we booked £30 million of income relating to settlements for overcharges from payment card processing fees, much lower than the £181 million recognized in the prior year and £35 million of IAS 19 pension income.
As already noted, the first half has been a period of strong underlying cash generation, with retail free cash flow benefitting, as I mentioned, from a more typical seasonal working capital inflow and higher Grocery sales in Q2.
Free cash flow also includes the cash receipt of a £50 million dividend from Sainsbury’s Bank, which was announced at the prelim results in April and paid in the first quarter of this financial year.
Now, it’s worth calling out the other line in the table, which in the prior year, primarily related to increased lease additions, from the Highbury and Dragon transaction, where we served notice in the first half of last year to purchase 13 stores upon the expiry of the leases. We plan to pay for these stores in March 2023 from cash flow and a term loan.
Excluding lease liabilities, we close the half in a net funds position of £361 million, representing a reduction in net debt of over £500 million from the year end and a reduction of around £400 million from last year’s first half. Net debt including lease liabilities reduced by nearly £600 million from the year end.
These charts show the strength of our balance sheet position, which is important in the current environment. Our net debt-to-EBITDA leverage ratio was at 2.9 times at the first half, down from 3.1 times at the year end.
As I have already mentioned, net debt is always lower at the half year. We would expect our net debt-to-EBITDA position to improve year-on-year to around 3 times at March 2023. This would be at the top end of our target leverage range that we laid out as part of our capital allocation policy in April.
Return on capital employed is down from year end, reflecting the impact of lower underlying profits. We remain on track with our key metric to increase return on capital employed.
So, overall, we are pleased with our first half performance. The backdrop remains tough, but we are really well placed. Our volume market share outperformance has been supported by the strength of our financial position and the ongoing delivery of our cost savings program.
Trading momentum has remained strong in the first few weeks of the second half, with continued volume market share gains. We continue to generate strong retail free cash flow and expect to generate free cash flow of at least £500 million for the full year. Looking ahead, we are well placed to deliver through Christmas and continue to expect underlying profit before tax of between £630 million and £690 million.
Thank you very much for your time. I will now hand you back to Simon to take you through our operational highlights and progress against our strategic priorities.
Simon Roberts
Thank you, Kevin. Let’s now turn to Food First, the first of our strategic priorities. There’s been a relentless focus across the business on keeping prices as low as we can at this difficult time for customers.
We believe we are in the best place we have been in a long while on value. We will have invested over £500 million in prices over two years by the end of this financial year and we continue to anchor this value investment at the centre of the plate, in meat, fish and poultry, and fruit and vegetables. This is really working for us.
We have three core platforms of value, as you can see here. First, is Sainsbury’s Quality, Aldi Price Match. Here, the focus is on products that customers buy most often, with 240 products in the Aldi Price Match campaign.
Second is Price Lock, where we have added 20% more own brand lines to keep everyday prices low on the core staples. Prices are locked for eight weeks on over 2000 products in this campaign.
Third, My Nectar Prices, which is becoming increasingly popular with customers seeking out Nectar points and offers to save money on everyday items. New offers are added every week, as we react to market dynamics and customer needs.
We have shown this chart before. It shows the strength of our value focus. We continue to consistently inflate less than competitors on the products that customers buy most often as shown here, as well as on the overall basket. This focus is working. We are driving more volume and more customers into Sainsbury’s, and we intend to keep building on this momentum throughout the rest of the year.
Here we can see our progress on value against our key competitors. We have continued to consistently improve our price position against all of them year-on-year. We have shown particular improvement against Aldi, improving our value index by 400 basis points year-on-year.
As you can see on both these charts, it’s all about how we help customers to find value and then, when they want to, help them to trade-up. Sales of economy own label products were up 11%. We have been gaining spend in this category from nearly all competitors, but with the strength and breadth of our assortment, we are uniquely well placed to win at the other end of the basket as well.
We are seeing great performance in our premium own label tier, Taste the Difference, with sales up year-on-year and up 13% from 2019/2020 and we expect to win more spend, as customers trade down from restaurants and look for treats and meal deals for special nights in and celebrations with family and friends.
Now to support that trade up, it’s really important that customers recognize the high quality of Sainsbury’s products and you can see here that we are ahead of our competitors, and we are on track to launch 1200 new products this year, with over 600 delivered in the first half. We extended our Summer Edition range and sales grew over 30% compared to last year.
We are delighted with our delicious, Autumn Edition range again this year, up from 47 products to 82 this year and we continue to balance our assortment by category, as we bring new lines into the ranges, whilst at the same time, we constantly take action on the tail.
So, looking ahead, we are well set up for this Christmas, as customers look for an extra special celebration. We will be launching 300 new Christmas products this year and nearly half of the Christmas innovation will be in Taste the Difference.
Let’s now take a quick look at some of our product innovation over this Summer and Autumn, including some of what’s to come this Christmas.
[Video Presentation]
So moving on to our channels, as you can see from the chart, online orders continue to normalize post pandemic, although the year-on-year decline is slowing. We did a better job than our competitors during the pandemic, making online delivery available to customers who really wanted and needed it. And so as customers have returned to stores, our online sales have declined a little more than the market.
We are encouraged by how this is playing out. We are pleased to see a higher proportion of customers switching back into our own physical stores than is happening at our competitors and this is reflected in our overall Grocery market share gains.
And we are happy with this balance back to physical stores, but we are also continuing to drive further online efficiencies and we see further opportunities here in our store pick model. Drop densities and item pick rates are both significantly higher than pre-pandemic and item pick rates have improved 4% year-on-year.
We are also pleased with the recovery of our convenience channel. Convenience sales are now 7% higher than they were pre-pandemic, driven by growth in our less urban stores outside city centers, whilst our smaller city center food on the move stores have recovered rapidly and are close to delivering pre-pandemic sales levels.
The chart on the right shows our overall channel performance and the switch back to our physical store estate. Our On Demand channel continues to grow and we are now delivering around 118,000 orders per week from nearly 700 stores.
And as customers choose to return to our stores, we are pressing ahead with our significant investment program to further improve the store shopping experience as you can see here. In fact, we will have touched nearly 90% of our supermarkets this year alone.
Prior to October, we finished relaying all our stores to meet the new High Fat, Sugar and Salt regulations. We have taken advantage, whilst making these changes to also upgrade our Fresh and Grocery offer in hundreds of stores, rolling out Beauty aisles, investing in checkout technology and creating destination space for General Merchandise.
So, now that I have talked you through the what of Food First, let’s move on and update you on the proof points of what this is delivering. This slide shows our relative resilience as customers adapt to cost of living challenges.
We have seen less switching to Aldi and Lidl than any of the full-choice supermarkets and while customers are spending carefully, our customers are dropping fewer items out of their baskets and trading down less through product choices. This is driven by the strategic choices we have made, the demographics of our customer base, our range and our strong brand position, supported by the geographic mix of our stores.
As you can see here, the trend in customer satisfaction is significantly impacted by inflation, dragging down value perception scores across all retailers. Nevertheless, customer satisfaction continues to be a key point of differentiation for us and we are maintaining our lead versus all of our full-choice competitors.
And you can see this across the four key drivers on the right-hand side of the chart. We continue to lead on availability of items, speed of checkout, quality of products and colleague availability. And this is the final point on volume market share performance.
We showed the left-hand chart at the start of the presentation. We are the only full-choice supermarket to grow or maintain our volume share position from where we were pre-pandemic, and we also grew volume share ahead of the market in the second quarter.
Moving on now to talk about Brands that Deliver. We are making good progress with the second pillar of our strategy and I am encouraged by the progress we have been making across the brands during the half.
Leveraging the full potential in Nectar is all about continuing to acquire new digital Nectar users. Nectar continues to grow and we have hit our target of reaching 10 million digital collectors. More SmartShop customers are benefitting from personalised Nectar Prices, saving customers on average over £100 a year.
Nectar360 is going from strength-to-strength, where we work with around 700 suppliers now every year. We previously said that we expected Nectar360 to deliver incremental profits to the business of £60 million to £70 million by March 2026. We now expect this number to be at least £90 million.
In General Merchandise, our objectives were to reduce our cost to serve and improve profit delivery, whilst delivering a better proposition for our customers. We are encouraged with the progress now being achieved, as we further improve our focus and capabilities in General Merchandise. Argos profitability levels are significantly higher than pre-pandemic, largely driven by a reduction in operating costs to sales.
Given the challenges last year, we have put a major focus across the General Merchandise business on improving availability and this is significantly better than last year. We are improving the assortment of ranges, customers are recognizing our strong value credentials and we have grown our digital market share in Argos.
To deliver full potential across Brands that Deliver, we need to build each of our brands so that they inspire and really connect with our customers. This slide illustrates some of the things we are doing to develop and accelerate our brand proposition across General Merchandise.
We continue to develop and grow our Tu clothing brand, with our latest Tu & Me campaign really resonating well with customers. And in Argos, we are increasing our premium mix by securing desirable new brands, such as Smeg, Neff and Mamas and Papas.
We have seen good sales growth in Habitat, as we build this brand. We are particularly pleased with the performance of the new Habitat Kids range across bedding and furniture, and we are launching an exciting design collaboration with Sebastian Conran, son of Habitat’s iconic founder, Sir Terence Conran, ahead of the brand’s 60th birthday in 2024.
We have seen a strong performance in Argos, particularly in the second quarter, where sales grew by 1.6% year-on-year despite pressures on consumer spending. The favorable summer weather also played to our advantage. We have been encouraged by overall market outperformance in Argos, growing share in all key categories, as customers have turned to Argos for value.
The chart on the left here shows the key categories that drove this performance. Consumer electronics and technology sales were strong and the warm summer weather drove seasonal sales of gardening tools, barbecues and outdoor toys. Sales in bigger ticket items, like furniture, have been challenged, as well as homewares, as discretionary spending patterns have shifted post-pandemic.
Now we remain cautious about spend heading into peak, given the pressures on consumers, but we are increasingly confident that if customers are spending, that Argos is very well placed to benefit.
We are now going to play a short video to bring to life changes we are making to Argos distribution network. Two years ago, we laid out our Argos transformation strategy, with a key objective of giving customers faster access to a wider range of products.
We are reducing our standalone store estate from 600 stores to around 160. Over 70% of Argos orders start online and 30% of fast-track delivery orders are delivered the same day, so it’s important to have stock in the right place to get to customers quickly.
Now a key part of achieving this transformation has been through replacing our distribution network of around 180 larger hub stores with 30 new local fulfillment centers, which you can see in this video, taking stock out of the system, whilst moving it closer to customers and creating real working capital benefits.
We have now opened 11 local fulfillment centers. They are purpose-built to deal with volume to stock broader ranges and enable smarter use of data and voice picking, and allow optimized routing.
In the areas where we have opened local fulfillment centers, we are seeing tangible benefits, with better availability of items on the Argos website and thousands more product options available to customers more quickly.
Overall, this half, Argos perceived availability scores have improved six percentage points and as we make and embed these changes to improve our distribution network, Argos will become even more efficient and synonymous with rapid and convenient access to a wide range of products, with great availability.
Moving on to Clothing, we are creating a stronger more profitable Tu Clothing business. Clothing sales in the half were 2.5% higher than pre-pandemic levels, with our full-price participation remaining significantly higher than in the first half of 2019/2020, driving a more profitable business. We delivered a record performance in women’s dresses in the half, with sales up 40% and we saw a good performance in Back to School clothing sales.
Now to Financial Services, here is a reminder of the objectives we laid out for the business in September 2019. We are making progress despite a difficult backdrop and we were pleased that the Bank paid its first dividend to the Group of £50 million in April this year.
As we have said before, we are focused on developing and delivering Financial Services products for Sainsbury’s and Argos customers. Our teams are joined up to deliver these plans and we are delivering this more efficiently with investment in digitization in particular.
So turning to our third key pillar, Save to Invest or put another way reducing structural operating cost to fuel investment in the core business. Now we have doubled the run rate of cost savings and expect to deliver over £1.3 billion of savings in the three years to March 2024. 18 months in we have delivered £730 million of these savings.
Now this is the first time we are talking to a cash target, which is partly to demonstrate the scale of the savings opportunities we have available relative to competitors, but also because much higher operating cost inflation than originally anticipated means that we will not now meet our 200 basis points operating cost to sales reduction target by March 2024. But let me be clear, we are ahead of the level of cash savings we committed to.
And looking to how we can continue to generate savings, so far our cost savings to date have been mainly driven functionally and focused on savings released from big structural operating model and proposition decisions.
Now while these opportunities will continue to play an important role, we have recognized the need to think differently and our focus is now shifting towards driving variable cost efficiency with a greater emphasis on driving productivity and pulling levers end-to-end across the whole business.
Now this slide shows some examples of what we have already delivered to-date on our key structural cost saving programs. We have also made particular improvements in our utilities costs, reducing our electricity consumption by 23% over the last three years, driven by numerous schemes, such as rolling out LED lighting to 100% of our stores and fitting aerofoil technology in our refrigeration.
We also believe we are in a good place relative to the industry on our proportion of new to planet energy sourcing. We have committed to the long-term purchasing of renewable energy from new windfarms, which gives us good protection from variable cost inflation. And we are also confident that we are in a strong hedging position relative to others on utilities for the balance of this year and into next.
In June last year we launched our Plan for Better commitments and we set out key targets with the three pillars of Better for You, Better for the Planet and Better for Everyone. We committed not only to setting bold targets, but also to being transparent in our reporting against them.
Now in the half, we set out five Human Rights commitments and added improved animal health and welfare as a key as a key pillar. We have been focused on working in collaboration with other retailers and the World Wildlife Fund to halve the environmental impact of the U.K. shopping basket by 2030 and you will hear more on this next week when the World Wildlife Fund publish their impact report.
We are particularly pleased with the progress we are making in tackling food waste. We removed best before dates from 100 more of our own brand products earlier this year, which is estimated to help customers save 11,000 tonnes of food per year. And in the year since we launched our partnership with Neighbourly, we have distributed over six million meals to those in need.
So we are now at the halfway point of our three-year plan and here’s a reminder of the eight key metrics we set out for that plan. I am pleased that we are making good progress across the majority of these metrics, and of course, we will update more fully at our prelims in April.
I am excited about the momentum that as a team we are building in Sainsbury’s. We have a very clear focus and we are executing well against that. Putting more volume through our Food business is the vital lifeblood that not only feeds the economics of the Grocery business, but also supports all our portfolio brands.
So, before wrapping up, I want to return to some of the themes I started with. We are now at the halfway point of our plan and we are delivering against that plan. We have got strong momentum and we are proving to be more resilient than our competitors. We are saving more costs than our competitors, offsetting more of the operating cost inflation and we are reinvesting more in our customer proposition and in looking after our colleagues. This is why we are winning volume share.
For our shareholders we are delivering strong cash flows, supporting dividend payments. We are a more profitable business with a stronger balance sheet and this means we are well placed to deliver in this environment and navigate the period ahead.
Thank you for listening and thank you for your time this morning.
Question-and-Answer Session
Operator
Hello. And welcome to the Sainsbury’s 2022/2023 interim results analyst Q&A call. On the call this morning are Simon Roberts, Chief Executive Officer; and Kevin O’Byrne, Chief Financial Officer. [Operator Instructions]
Our first question is from Andrew Gwynn from BNP Paribas Exane. Please unmute yourself to ask your question.
Andrew Gwynn
Hi. Good morning, Simon. Good morning, Kevin. How are we doing? And two questions if I can. So, firstly, just talking about the control of the P&L, clearly a bucketload going on in terms of cost inflation, in terms of recycling the cost saving. But I suppose very simply, where did you land versus your expectations in the first half given all that noise? And then the second one, obviously, two key bits of guidance here, so the PBT guidance and then the cash flow guidance. And what would cause you to deviate from those significantly, is there something that you are watching from a consumer metric perspective, is it simply just a relative performance versus your peer group? Thank you very much.
Simon Roberts
Andrew, thanks. Kevin, do you want to pick up on those couple of questions first?
Kevin O’Byrne
Yeah. Yeah. Andrew, good morning. Yeah. The first half was broadly as we expected and we said that we would had volume reducing post-COVID in both businesses which we saw. We said we would invest in food value which we did.
And we had maybe a little bit more impact from product mix in Argos, there were more electricals in the mix than maybe we would have anticipated and but we had higher cost inflation which we anticipated and that was largely offset by our savings plans, which of course we anticipated.
So there wasn’t a huge surprise, if you like. And on the demand side, probably the demand side in Argos was stronger than we thought in the second quarter, but as I say, we had a mix in there as well, that was probably, Simon might add something to that.
On the PBT guidance, really it’s all around consumer demand. We have got absolute visibility of our costs, as you can imagine, we are fully hedged for the year, we have got – so all that’s in the bag and the range will depend on the demand in the final quarter, particularly around General Merchandise and what that’s at.
The other factor that’s in there a little bit on our mind is impairments in the Bank and just how will that work out. Clearly a chunk of that is looking forward in the economic models and what IFRS requires us to do, which we will get greater clarity on in the final quarter as well.
Simon Roberts
Yeah. Thanks, Kevin. Maybe just a couple of points on the demand side, Andrew. I think looking in the Argos business, I think, clearly the self-help actions that we are taking, like availability and range and convenience, are really working. Clearly it was a strong summer from a weather point of view and undoubtedly that gave us tailwinds, particularly in the Argos business, given obviously the strength of the seasonal business there.
I should also just pull out the momentum in food, we have seen momentum. Volumes clearly in the industry are going backwards, but our relative volume performance against others in the second quarter we are really encouraged by. I think the combination of what we are doing, both on value but also on the breadth of the overall offering in food, really play to our advantage there.
Andrew Gwynn
Okay. Thank you. I will just come back on the cash flow. Obviously the guidance is for north of £500 million, but you are substantially ahead in the first half. So should we just take into account you are saying at least £500 million and we will see where we land or is this something we should be aware of in the second half on cash?
Kevin O’Byrne
No. It’s at least, Andrew, but bear in mind the first half always is flattered by the working capital and we had the normal, if you went back three years pre-COVID and you looked at our working capital at the half year for each of those three years in what were potentially normal years and you would have seen £250 million to £300 million of cash flow coming in in the first half, because of just the timing of payment cycles and then coming out. So that’s a factor in there. It clearly was exacerbated a little bit this year, because you got more inflation in the number and we would expect that to largely unwind.
Andrew Gwynn
Okay. Great. It’s been a while since we have had a normal year, but thank you very much. Cheers guys.
Simon Roberts
Yeah. For sure. Thanks, Andrew.
Operator
Our next question is from James Anstead from Barclays. Please unmute yourself and ask your question.
Simon Roberts
Hello, James. Good morning.
Kevin O’Byrne
Hello, James.
James Anstead
Good morning. I have got three questions if that’s okay. Firstly, I appreciate it’s really difficult to come up with any representative way of judging cost savings at the moment, but you have given us this impressive doubling of the run rate in the next three years. I just wanted to be sure, because that seems to be judged off 2021, when obviously there were lots of extra costs relating to the pandemic. Is that adjusted for, I just wonder whether the doubling of the cost savings is entirely the best way of thinking about it? That’s the first one. Secondly, you have also now said you will have 160 Argos stores by March 2024 rather than 100, because of better rent negotiations. Do you think it stops at 160 or do you think it will get to 100 but just more slowly, just interested where that goes. And then finally, perhaps for Kevin, it’s obviously a very good problem to have £300 million or so of net cash and it doesn’t sound likely you are planning in the very short-term to start returning that surplus cash, given the guidance for leverage at the end of the year. I just wondered if you could remind us other sources of use for that cash in the coming year or so. I know Highbury and Dragon might be part of that answer? Thank you.
Simon Roberts
James, thanks. Why don’t I take the cost and Argos question and then I am sure Kevin will speak on costs, he may also want to come in on the specifics of the COVID costs as well. Yeah, I mean, just taking a step back on our cost trajectory, you will remember in November 2020 we said we would reduce by 200 bps on costs over three years.
And what I would say, first of all is that, we are really encouraged with the progress as a team we are making here. These are hard yards taking structural costs out of a business like this, and as you can see, in a number of areas we have really delivered against that plan. We are actually a bit ahead of where we thought we would be at this point in time.
If we think about the key cost areas in areas like supply chain logistics, clearly the Argos transformation, the work we have done on the proposition in food on cafés and counters and then really significant work in our channels on our store operating model.
And so, really what we are confirming today is this £1.3 billion of costs out of the business to March 2024 reflects the continued scale of that ambition and whilst, as you say, there was some ups and downs on the COVID costs on the way through the 2021 period. When we look back at what the costs coming out of the business were to 2019/2020 and we look at what we are doing now, we are more than doubling the rate of cost takeout.
Just one other point, James, I would make here, which I think is an important one. We have really focused on functional cost savings and on proposition cost savings to this point, and very much now we are going to continue to deliver down those paths, for obvious reasons, because they will be essential. But we are also very much now looking at end-to-end cost savings, productivity savings and also how we drive the operating leverage in the business.
So it’s a bold plan, we are mature in our cost savings, we are confident about where we have got to and we can see a lot of opportunity in front of us. I guess the key point on cost, we think we have more cost out in front of us to do relative to our competitors.
In terms of the question on Argos, let’s just take half a step back on Argos. We are pleased with the Argos performance in the half, particularly in the second quarter to — and to Andrew’s question earlier, we had some weather help there. But the self-help in Argos that the team have led and availability particularly, and clearly in the cost out in Argos as we reshape the operating model.
I think in terms of the number of stores here, we said at the beginning 160. As you say, we have had some more favorable rent negotiations with landlords. Our objective was always to make sure we have the optimum number of access points for the Argos business and this will mean at the end of the three years we will have around 1,100 points to access Argos, more than clearly we started with before.
Just under 800 standalone stores, 1100 points to access Argos and we have managed to do that through some really strong and effective negotiations from our property team to get more stores in locations where we can serve customers at a lower cost, and therefore, continue to improve the economics of the Argos business. Kevin, do you want to add – do you want to come to the third of James’ questions on cash?
Kevin O’Byrne
Yeah. James, yeah, on net cash, it’s a great milestone actually. We are very pleased that we got net cash at the end of the half, we haven’t had that before and going forward you expect net cash at the end of the year.
But I will remind you of the capital allocation policy that we laid out last year. First of all, invest to strengthen the business, which we are doing. Secondly, solid investment grade, really important and all the more important I think right now, given the world we are facing.
So there’s more to do on that, we should get to a 3 times net debt to EBITDA by the year end. We have said our target range is within 2.4 times to 3 times, so a little bit more to do on that so we will continue to do that.
We also very importantly said, we — in the meantime we would still pay out a greater proportion of profits to shareholders and we would go from what was roughly about 53% distribution to about 60% because of our confidence in the cash flow.
And we know in the end all cash flow is shareholders, so we want to give more of that in the meantime to shareholders and then after that we will decide are there things we want to invest in over and above that or would we return surplus cash to shareholders.
That leads onto your second part, which was the Highbury and Dragon, which as you recall we exercised the option in two different tranches to buy 21 stores back from this structure. And you will recall at — back in September we were looking at would we sell and lease back 18 different stores to part fund that.
In the end, the market wasn’t good at the time, the transition didn’t go through and we certainly never want to be or need to be because of the strength of the balance sheet a forced seller at the moment. So clearly we are not going to sell properties into this market.
So we will fund the 21 stores from some debt and some cash and so you will see in the post balance sheet events we have put a bridging loan in place, we will replace that with a term loan. And the good news then is, debt — net debt doesn’t really change that much, because we are replacing lease debt with bank debt. But it is positive from a cash flow point of view, because the rent we would have paid we will pay less cash in interest, so we are comfortable with that.
James Anstead
That’s very helpful. Thank you.
Simon Roberts
Thanks, James.
Kevin O’Byrne
Thanks.
Operator
Our next question is from Rob Joyce at Goldman Sachs. Please unmute yourself and ask your question.
Simon Roberts
Hello, Rob. Good morning.
Rob Joyce
Hi. Thanks for…
Kevin O’Byrne
Hi, Rob.
Rob Joyce
Good morning to you two. Thanks for taking the questions. I have got three. So in the outlook statement you reference being well placed into next year. Just looking at consensus, it looks to have around a flat EBIT margin in the retail business next year versus maybe down 40, 50 this year. Just wondering if that seems consistent with your comments on being well placed and where you see costs? Second one was just a follow-on really, Kevin, thanks for the comments on Highbury and Dragon. Just to understand, for those of us still using old money, in terms of the impact on net debt pre-leases what do you think, I think the purchase price was just over £1 billion from what I have seen from Supermarket REIT. So if you could help us understand that and maybe also just tell us what the expected rental savings would be, that would be really helpful. Then the third one was just you referenced volume quite a lot in the release. It does look from the external data, not specifically for you but that market three-year volumes took a bit of a downturn in September. Can you just help us understand how your three-year volume momentum has been in September and into October? Thank you.
Simon Roberts
Rob, thank you. well, maybe Kevin, if you take the outlook…
Kevin O’Byrne
Yeah.
Simon Roberts
… and the net debt and then I will take the volume question. Yeah.
Kevin O’Byrne
Just starting with the Highbury and Dragon one, we would envisaged taking out – you will see we took a bridging loan of £575 million. The transaction net is probably about £700 million that we need and so we probably put — we will put a loan of that size in place, whether we need it all or we will do some from cash we will play that, but let’s say it’s £575 million. So you would add that to the pre-lease debt and then we will then eat into it over the next few years and so at the most it will be £575 million, probably be a bit less.
And the rent saving, had we done the 18 stores depending on the agreement, £45 million to £50 million of rent, so the interest on that will clearly be materially lower, so that’s good from that point of view.
As far as being well placed into next year, look, I thought we might get a few questions on next year and as you can imagine there’s a limit to what we can say. But we are very aware it’s a tough backdrop and it’s clearly too soon to be very specific. We do our budgeting processes after we get Christmas trading, so we will come back and give you more detail as we enter the year.
But there are some things we do know and some things we don’t know. And we know it’s a rational market at the moment and we can see people behaving in a rational way. We know we have got momentum from the plan and the actions that Simon laid out in the presentation, so we are in a good position with the underlying momentum in the business. We know we have got a mature Save to Invest program that’s delivering and we have clear line of sight of future savings.
And there are areas, while inflation – we also know there’s going to be more inflation clearly next year, particularly in labor and utilities, but we have some visibility of that. So we have — we are 75% hedged for our utilities for next year and we have clearly got some visibility and a view on labor. So we kind of know what we are dealing with to a large degree there, although still lots of other uncertainty.
What we don’t know, of course, is the level of demand, which is why we do our budgeting process after Christmas and closer to the financial year end and that’s the big unknown. But overall we think that everyone’s facing that demand question, so we think we are relatively well placed without being in any way complacent, because it’s a pretty, it’s a tricky environment out there and we are making decisions literally day-by-day, as you can imagine.
Simon Roberts
Yeah. Thanks, Kevin. And then let’s just come to volume specifically, Rob. So, clearly, as you say, volumes in the market clearly are down, we know that. The key point that I’d really want to emphasis here is our relative volume to others, as you have seen, through the half has been strong and also our relative volume to the full-choice supermarkets compared to pre-pandemic, as you have seen, we are the only one that’s growing.
So the context is really clear. We can see customers putting less in the basket. We can see some trade down happening and as you describe, as inflation has picked up into the autumn those forces have accelerated.
What I would say and one of the things that clearly we are very focused on is the fact that we are seeing less switching to the discounters. We are seeing that continue as we come out of the half. Our basket sizes are holding up better relative to our competitors and we are seeing a bit less trade down too.
And I think those three components in what clearly is a very challenging set of market dynamics at the moment, we are really focused on those because in the end they are the test as to what extent our focus on value on our food offer is really working.
Clearly no complacency in that, it’s going to be a competitive period up to Christmas. I think we are going to see the market behave rationally, but clearly as customers are absolutely seeking value everyone’s going to respond to that.
So our strategic focus on value, on making sure customers trust the price on the shelf in the basket and that we not only help customers manage as they trade down but also take opportunities to leverage our mix as well.
And that’s why one of the key points I wanted to just emphasis today, we are seeing that trade down, we are seeing customers shop in to Own Brand for sure. But we are also seeing customers trade up and you saw the Taste the Difference performance up 14% on three years and you can see what we are doing at the top end of the mix to really leverage that.
If it’s helpful, just a word on GM, because I think, clearly, we have had a strong quarter two in the Argos business, some self-help’s really driven that, the weather’s been helpful. But for obvious reasons we haven’t seen yet the start of the real build towards Christmas.
And I think if there’s one big area of uncertainty on our minds it’s just to what extent consumer spending will really pull back. We will only really get our first feel of that over the next three weeks or four weeks once we get towards the end of November.
Rob Joyce
Very helpful. Thank you, both. Just a follow-up, just to help us understand the magnitude since the summer and the sort of volume fall off, are we talking a percentage point or so? If we think volumes are down minus 1 or they are now running at minus 2 or whatever the number is on a three-year basis, can you give us any understanding of how that’s magnitude is trending?
Simon Roberts
Yeah. I mean, it’s not a significant shift, Rob. I mean, I think, as the inflation cycle picks up, clearly customers are responding. And we look very closely at the relationship between inflation up and volume in the basket.
And one of the things I would just draw attention to that, I think, we are seeing in our demographic and geographic mix, is as inflation has gone up we are seeing a bit less impact on the volume dropout than others. And I think that’s a function of both the demographics of the Sainsbury’s customer, but also the predominance of our geography base as well.
Rob Joyce
Thank you.
Simon Roberts
Thanks.
Kevin O’Byrne
Thanks, Rob.
Operator
Our next question is from Clive Black at Shore Capital. Please unmute yourself and ask your question.
Simon Roberts
Good morning, Clive.
Clive Black
Yeah. Good morning, gentlemen. Thank you for the questions as everyone else has said. I wouldn’t just mind asking a few questions about consumer behavior and sentiment, so it’s a single question with three parts. First of all, how do you see consumers viewing the differential in price between proprietary brands and private label? This is something they are talking about and noticing and maybe your own thoughts about how that differential has changed in recent months, noting one or two major branded operators have actually expanded margins recently. And secondly then, some of your competitors have spoken around consumer behavior, things like end of month versus midmonth use of cash. I’d just be interested in the anecdotal of how you are seeing shoppers actually operate in your stores. And then lastly, just a slightly broader piece and have you seen the shopper’s interest in ESG matters, which you talked about in your presentation, Simon, adjust as times become more difficult? Thank you.
Simon Roberts
Thanks, Clive. Well let’s get right into the heart of how customers are really behaving, to your question. So, look, I think on the first point, just to emphasis and we all get this, don’t we, it’s really tough out there and customers – and I said at the Q1, customers are watching every penny.
Clive Black
Yeah.
Simon Roberts
And I think whatever we felt then, double plus double what it’s feeling like now. Literally every product selection at the shelf edge, customers are watching every penny that they spend and I think that’s playing out in this shift towards own brand.
I think it’s evident when you stand at the shelf of the own brand products and you look at branded products, they are broadly half the price and customers are making choices based on that very clear value decision. We are seeing the shift to own brands and we are seeing customers on those everyday stables they buy week in week out, cereals, canned and packaged products, household products, making those choices.
The thing that we are very focused on, we have got a very strong assortment in Sainsbury’s, it’s something we are very proud of, we think it’s a point of difference. At each of our product tiers the teams have been doing a lot of great work to make sure our own brand product base is very strong, both at the main tier, but also as I describe it, the premium tiers as well.
So, look, I think we are going to see this trend continue. I think customers are going to buy into more own brand products as they see their relative quality and value and it’s something we think we are well set for.
In terms of consumer behavior as we head towards Christmas, and I think it’s very clear, as you say, customers are looking to spread the cost of Christmas out. They started to shop earlier and that was both a function of when they are getting paid, so month ends have become more important and we have been gearing up to take advantage of that.
We saw in the General Merchandise business, for example, early buying of things like Christmas gifts and Christmas decorations way earlier than normal, as customers look to try and bring some of that spend forward.
And you can see in the market data how month end particularly has become a real planning point for customers. We have seen that at the end of October, we will see it at the end of November, I am sure, and we will see it as we go ahead.
Clive Black
Yeah.
Simon Roberts
Specifically, just in terms of in the Argos business. You know one of the things about the range in Argos, clearly is, we sell a whole bunch of products that help customers save energy. And so we have seen a huge increase in the amount of energy saving products, whether that be electric blankets, whether that be air fryers, whether that be airers. We have had very good availability to be able to really take the opportunity of giving customers access to those products.
And look, I think as we look ahead, as I said earlier to James’ and Rob’s question, it’s really hard to call the GM demand for Christmas yet. I think we are not going to know that really until the end of November. But it’s inevitable, isn’t it that the impact of just how tough it is, is going to play through. The question is to what degree. We think the value in the Argos brand, particularly, should be helpful to us and the momentum we have got and availability is clearly important too.
And then just on your point on ESG, Clive. Look, I think, let’s really talk about what customers are talking about. They are talking a lot about plastic. Plastic and the amount of plastic in food packaging, we went through a pandemic where everyone wanted to see products covered again, for obvious reasons.
And it’s a big focus for us, we are very focused on how we take as much plastic out of our product base. Working very closely with a number of key supply chains in how we do that, because these are big structural, as you know, changes that need to happen over a period of time.
And then the other big area of focus for us has been food waste as well. And we have taken best before dates off a further 100 of our products where there’s no compromise on quality. We are doing everything we can to bring down food waste and also help customers to bring down their own food waste too as they look to make the most of every penny on food that they spend.
Clive Black
And then just by way of follow up to that, Simon, you say customers are counting every penny. Do you sense there’s a risk, if that’s the right term, but coming into Christmas we will see people maybe really prioritize food and beverage as something related to experiences, which may lead to very weak gifting or artefact demand?
Simon Roberts
Well, look, I think, as I say, I think, it’s early to see on the gift side. But I think it’s inevitable people are going to prioritize their spend. I think they are going to prioritize their spend actually on food and beverage at home.
I think we have got a World Cup just before Christmas for the first time and I think, that’s going to be a big at home occasion. I think people are going to want to buy food and beverages to drink and enjoy at home with family and friends. We are gearing up for that.
There’s a lot of focus on the cost of living, on watching every penny. But I think customers will look to want to treat themselves this Christmas, particularly in food and that’s why our focus as a business on Taste the Difference is going to be a really key part of our Christmas plan.
Christmas customers are going to want to enjoy themselves this Christmas, but in a way they can afford. So we have got 300 new, as you have heard, Taste the Difference products, a big focus on innovation.
So helping you to enjoy Christmas in a way you can afford it, same with the World Cup. We are seeing spend in restaurants really come off the last few weeks as customers spend more time and make their budget stretch further at home and we are gearing up for all of that.
And look, on the GM side, I think, it’s inevitable spend on gifting will be less. But it will be on the kids and it will be on making sure that there’s great value and experience in the gifts that people buy. You would expect me to say this. We think we have got a really strong range of products to do that. This time last year availability was a big challenge in General Merchandise.
Clive Black
Yeah.
Simon Roberts
This year we are in better shape. So as customers pull their spend earlier, we have got to be ready to make sure we can serve them and help them when they want to shop.
Clive Black
Well, I hope you are set up for Wales to beat England in the World Cup and not be too shocked when Iran beat England as well. All the best.
Simon Roberts
I couldn’t possibly comment on those predictions, Clive. Thanks.
Clive Black
Thank you.
Operator
Our next question is from William Woods at Bernstein. Please unmute yourself and ask your question.
Simon Roberts
Good morning William.
William Woods
Good morning, Simon. Good morning, Kevin. Thanks for taking my question. And two please, the first one is just as part of the Food First Strategy, you have obviously continued to kind of under inflate the market to improve relative price perception. Do you think that this continues to be necessary and do you have kind of a relative pricing level in mind that you are looking to get to? And then the second one is, just on kind of H2 margins, obviously H2 should be seasonally stronger in terms of profitability. Would you expect the same this year even if demand is weaker and should we still see those kind of better margins?
Simon Roberts
William thanks. Well, look, let me pick up your first question on Food First and where we are on value and Kevin can perhaps help us on the second half margins. Look, on the fundamental principle of our Food First Strategy was to improve the competitiveness of Sainsbury’s. and look, clearly, as you can see in our results today, that’s really working for us.
It’s working in improving our relative volume market share performance compared to others and it’s working in building the trust and loyalty of Sainsbury’s customers in the value offer that we have and in the broader product offer that we have.
So we are really clear it’s a key part of our strategy and as you know our cost program and the work we have been doing on our negotiations with suppliers are a key part of our self-help to underpin that.
That being said, we think this market will continue to behave rationally. We want to make sure that we present our offer competitively within that context, and so we have said before and I will say again, we would expect to inflate 1% to 2% behind the market. But we will focus our value investment into those parts of the shopping basket that really matter to customers.
And we were clear up front that centre of the plate really matters, meat, fish and poultry, fruit and vegetables. And as we have deployed our value investment, £500 million over two years into these areas, it’s really working for us, because it’s giving customer’s confidence that if I can buy those items in my shopping basket at even better value than I thought then I will shop the rest of the store.
And that shopping the rest of the store is really important, because of course, we have got this assortment in Sainsbury’s that we are really proud of and customers really want to buy into. I have talked about Own Brands today, I have talked about Taste the Difference.
And so our focus on value is win the centre of the plate, inflate behind the market in a market that we think is rational and use our cost saving program to continue to be able to drive that strategy forward. Kevin?
Kevin O’Byrne
William, on the H2 margins and we would anticipate year-on-year that we will have lower margins in the General Merchandise business largely and that’s a mixture of rate and demand, and obviously, they interact, because if demand is lower than we expect, we would expect people maybe would try and trade a bit harder and then we will see rates up. It will be in the mix there and we will be able to tell you more about that after we have gone through it. But that’s our working assumption year-on-year, which probably isn’t a surprise.
William Woods
Understood. Thank you.
Simon Roberts
Thanks, William.
Operator
Our next question is from Xavier Le Mené at Bank of America. Please unmute yourself and ask your question.
Simon Roberts
Good morning Xavier.
Xavier Le Mené
Thank you.
Kevin O’Byrne
Good morning.
Xavier Le Mené
Good morning. Two questions if I may. Just on Price Match actually, can you comment where you are with Price Match and sharing some color about the performance you have got? So the percentage that you said, is it increasing year on year on what you are supplying going forward? The second one just technical but what’s the impact of Fuel on your retail profit actually?
Simon Roberts
Okay. Thanks Xavier. Well, let me pick up Price Match and Kevin might want to speak on fuel and let’s try and answer your questions for you as best we can. So, look, on Price Match, it’s a key part of our value platform, as you know. And we are well — this is a very mature program for us now, and as I said, in the presentation this morning, it’s really working for us. So, 240 products in our Price Match.
One of the elements that I would really draw attention to is the fact that our Price Match is very geared to fresh food. When you look at what we are doing here it’s all about meat, fish and poultry, it’s all about fruit and vegetables, it’s all about dairy. The products that customers buy in high volumes regularly.
And the key component of our Price Match focus is that when customers look at these products at the shelf edge or online, every time they shop, they get real confidence that our price is parity with Aldi and Lidl. And that’s a really important point for us to make and it’s really working for us, so 240 products today.
You will see us as we head towards Christmas, make sure we maintain the strength of our competitive offer and the volumes in those categories where we have anchored the Price Match clearly have increased as we put more through Price Match. Kevin?
Kevin O’Byrne
Just, yeah on fuel Xavier, it’s a category is performing well for us, we are pleased with the performance. We are gaining share against the supermarkets and against the majors and we are growing volume. So that’s really good.
And we think of it as one category among a range of categories. It’s interesting, the industry has moved away from incentivizing fuel. You see fewer promotions in fuel than you would have seen in the past to incentivizing food, largely and which, again, isn’t a surprise, I guess, given the pressure of people’s wallets as we said.
If we put it in the scale of things, it’s similar to sort of frozen food in our business as far as sort of category contribution. It’s performing well and it’s helping us balance the better value that we are giving customers across the range.
Simon Roberts
Just Xavier, just last point just to help on your question on Price Match and as I said over 90% of the volume of Price Match is in Fresh categories, just to really emphasis the point about where all the investment’s going.
Xavier Le Mené
Thank you so much.
Simon Roberts
Thank you.
Operator
Our next question is from Sreedhar Mahamkali from UBS. Please unmute yourself and ask your question.
Sreedhar Mahamkali
Yeah. Hi. Good morning, Simon.
Simon Roberts
Hi, Sreedhar.
Kevin O’Byrne
Hi, Sreedhar.
Sreedhar Mahamkali
Thanks for taking questions. Sorry, my video isn’t working, apologies. A couple of questions. First one, I think, Simon you said, you have got a good picture of costs. You said 75% hedged on energy, good view on wages, et cetera. And you have also talked about significant ambition in cost saving. As you look forward into next year, do you see these cost headwinds, that you clearly have a pretty good idea of, will they be playing a draw as you have stepped up cost savings, do you think or is that not quite how we should think about? That’s the first one. And secondly, going back to GM, you have talked about very different profitability profile at Argos and GM. A couple of short questions there. Can you talk to any contribution to profit in GM in the first half? Did you grow profit from GM in the first half? And for the full year and into next year, how strongly is GM profit contribution tied to sales versus self-help? I know sales is always important but I am just trying to distinguish how the model worked historically versus how it is working now. The point you made about leverage being a very different dynamic now, especially at Argos?
Simon Roberts
Sreedhar, thank you. Okay. Well, let me start by just trying to give you a greater sense on the cost and then, Kevin, let’s talk about the GM margin. So, just taking half a step back here. As Kevin said, I think, look, it’s too early to talk about next year, and I think, as you would expect me to say, we need to wait for the outturn of this year, because a lot could happen between now and the beginning of next year.
But that being said, I just want to emphasis, we believe we are in a strong position for really three reasons. The first is, we have a mature cost saving program now. As you know we started this over two years ago now and we have been very focused as a team on structural cost out of our operations and on opportunities that we think we have in front of us that others either don’t have or have already exercised against.
So first point to make is that we think we have got a lot to go at here. Second point to make is that we have got clear visibility, as you have indicated, clearly, in utilities, in energy costs, but also in labor costs as well. And as Kevin said earlier, we are fully hedged in energy this year. We are 75% hedged next year. We have clear line of sight clearly as to where that hedging is and what we are also and seeing in terms of our plans on labor costs as well.
So I think that visibility is enabling us to plan for what we need to have in place next year and look, clearly, operating cost inflation is bigger, much bigger next year than we have seen before in those areas. But we can see the direction of travel and we can see the cost plans we need to have in place to make sure we are on the front foot here. I think look, the other point to make is that, our momentum in cost saving we think is strong and we are clear about how we are going to continue to accelerate it.
And then just moving on to the Argos point before handing to Kevin. Look, I think, the Argos costs program, Cost Transformation Program and I would broaden it to Customer Transformation Program, we are really encouraged by. You can see the performance in terms of our relative market share improving. We are taking costs out of the Argos business, but we are also growing market share as we do it.
And as you know, as we have effectively deployed heart and lung transplant on the Argos distribution and fulfillment model, we have been able to improve our customer metrics. And therefore that operating leverage in the Argos business is here to stay, because we have structurally taken so much cost out of the business. Kevin in terms of our GM margins, anything you want to add?
Kevin O’Byrne
Yeah. Sreedhar, I will just draw your attention to slide 34 in the pack, which just shows what we have done with the cost base and the operating profit. We are pleased with the performance in the first half of Argos from a profit point of view. It’s growing versus 2019/2020, it’s down versus last year as we would expect with volumes down, and of course, costs out are critical.
Another little anecdote for you, we started when we bought the business we had about 725 stores. Today we have about 725 stores with 415 of them – 414 of them are in our own stores so effectively rent and rates free, so you can see a massive focus on cost.
We have also had a big, big focus on margin discipline we have talked about before, which is very important, but, of course, sales clearly are critical in any retail business. There’s an element of fixed costs that we will always have and so we need to hit the sales. There’s a combination of all those things, but real cost discipline, real margin discipline and then…
Sreedhar Mahamkali
Yeah.
Kevin O’Byrne
… driving sensible sales behind that.
Simon Roberts
Thanks, Sreedhar.
Simon Roberts
Thank you.
Operator
Our next question is from James Grzinic from Jeffries. Please unmute yourself and ask your question.
Simon Roberts
Hello James.
James Grzinic
Yeah. Good morning team. Hi. Good morning. I had a couple of questions. The first one is on – just really on cost, on hedging on utilities. Can you perhaps help us, because, of course, we might have visibility, but the level may not be good depending on where spots will be next year. So, can you help us understand at what levels you are hedged for most of next year? Secondly, still on costs, we have seen one of your peers introducing the £11 level for starting wages, you are talking you are well covered on next year on labor. Can you perhaps help us understand, yeah, I think, you are £10.25, where are you thinking you are going to be settling next year on wages? And I guess, thirdly, where do you think the mix of margin will develop next year, given what you said on fuel, what you are saying in terms of consumer behavior? Perhaps, to summarize it, I guess, if you give us a sense of where you think OpEx inflation will be for your cost structure next year, gross of the costs saved, of course? Thank you.
Simon Roberts
Okay. Let’s try and navigate through all of those questions. So, I mean, look, I think, we have given you as much as we can give you on hedging, but Kevin, let me just…
Kevin O’Byrne
Yeah.
Simon Roberts
…check with you on that. I will then cover wages and let’s come back to the next of your questions.
Kevin O’Byrne
Yeah.
Simon Roberts
Anything else on hedging?
Kevin O’Byrne
Yeah. James, we are inevitably going to disappoint you with our answers here, as you can imagine.
James Grzinic
I expected that.
Kevin O’Byrne
But, look, on hedging, we have hedged, we believe, relatively well. Clearly we are not going to give the rates, because that would be competitively sensitive. Our utilities will cost more next year than this year, because clearly, you just need to look at the price curves. But the important thing is we have visibility, we kind of know what we are dealing with and therefore we can take actions to offset it.
One thing, I would say, coming into next year, we will have about a third of our electricity will be long term contracts for wind and solar – mostly wind, vast majority wind, so that does help us. These are contracts that we have signed, some of them a number of years ago, some of them more recently, so that gives us an underlying chunk of our electricity and we are a big electricity user, as you would imagine, so that’s helpful. And that’s probably all I was going to say…
James Grzinic
Sorry, Kevin, can I just ask you a follow up on that point, so if you can help us further. If we think about your total energy costs, how much is electricity, is it 50-50, so?
Kevin O’Byrne
No. it — the electricity will be a bit more – will be more than gas, but we will have a third of that, as I say, we get from the electricity usage…
James Grzinic
Okay.
Kevin O’Byrne
… from new to planet.
Simon Roberts
Thanks Kevin. Okay, let’s talk on wages then, James. So, look, I mean, I think, just take half a step back and then the look ahead. Look, clearly as you know, we have taken a leadership position in the industry on colleague pay, we feel very strongly about it. Our teams have done and continue to do a brilliant job serving customers and you can see that playing out in our continued strength of service performance.
James Grzinic
Okay.
Simon Roberts
Look, I think, it’s no accident, right, we want to really focus on supporting our teams, particularly at the moment when the cost of living challenges are really impacting everyone. So, that’s why we made a second pay increase this year, we were the first to do it. You will remember at the beginning of this calendar year we were the first to announce our move to our new rates in March and then we have gone again in September.
So, your question looking ahead, I think, this is clearly an industry wide issue, everyone is looking at how they are going to be handling pay rates going forward, as I have just indicated. It’s one of the things we have been thinking about and planning for, for a long period of time.
When we think about our labor costs, we talked earlier in the year, around £4 billion of our costs are in labor and so it’s one of the first things we clearly look at in our planning of costs. And I am not going to share with you now our plans on colleague pay into next year, but I would say we have clear visibility of our plan, we have been planning for it.
And when I talk about our cost saving program, I would just come back to three components of that. Structural cost out, we are ahead of where we expected to be at this point in time and so as we play forward, those benefits are now in our costs stack.
Secondly, we are very focused, as a team, on productivity in our operations. Now, clearly, lots is happening about how customers are shopping differently. For example, more customers are self-checking out, are digitally checking out, that’s helping us to really look at our productivity in our operations.
We are seeing less customers shopping online than we saw certainly at the height of the pandemic and even at the start of this year, so as more customers come back into store, that helps the economics of our operations. You can see in our presentation today we have actually won or attracted back more of our customers into store than our competitors, our fulfillment costs come down as we do that.
So, the reason I draw attention to that is there’s clearly a lot of inflation in wages but there’s also a lot of operational self-help and customer behavior change that’s in our planning for how we think about that.
And then, look, specifically on next year and apologies for the repeat on this. I think the position that we see here is it’s just too early to call the components of next year’s outlook yet. We will learn a lot over the next few months.
But I would just come back to, again, the three fundamentals, which is we have got a lot of good momentum in the business. We are really focused, as a team, on our performance and on our delivery of profit performance particularly, you can see that in the rate of our profit accretion since 2019/2020 in the first half.
We have got a real focus on our cost saving and transformation programs, they are on track and in some areas they are ahead and we have got clear line of sight of what we are doing on the next phase of those programs. So, the outlook has got a lot of challenges in the macro, but we think we are well placed to navigate those.
Kevin O’Byrne
James, just maybe just to give you a little bit more help on the last question. It’s roughly 80-20 electricity/gas, but to some degree a little bit academic, because we are hedged on both, and obviously, they are very linked, the price of gas feeds into electricity.
James Grzinic
Thank you. That’s very helpful. Thank you.
Simon Roberts
Thanks James.
Operator
Our next question is from Nick Coulter at Citi. Please unmute yourself and ask your question.
Simon Roberts
Hello Nick. Good morning.
Nick Coulter
Good morning, gents.
Kevin O’Byrne
Good morning.
Nick Coulter
Good morning. As ever, thanks for taking the questions. Apologies, I have three, and maybe I could go one by one to ease the process. Firstly on energy, would you be able to share the broad rate of inflation that you have seen on utilities or energy in the first half just to kind of give us some anchor to the debate. And then, I guess, a quick supplementary on that, on the nature of those long-term contracts, are they fixed or are they index linked? How do they work please? Thank you.
Kevin O’Byrne
Okay. On that, Nick, I mean, no, we won’t share, unfortunately. We just think it’s giving too much information to start breaking down our cost base that we have incurred on utilities. Those contracts tend to be between 10 years and 15 years and largely fixed.
Nick Coulter
Okay. Great. Thank you.
And secondly, on – I know the demand environment is febrile, but how have you planned your Argos inventory for peak please? Obviously, you were talking to high single-digit sales declines for the year, at the start of the year, there’s clearly inflation in the mix, there’s better availability, easier supply chain. So, how should we think about how you are approaching peak from an inventory perspective? And it would be great to get your thoughts on the dollar impacts coming down the track in general merch as well? Thank you.
Simon Roberts
Yes. Maybe I will just pick up on inventory, and Kevin, I am sure will want to add to this. And I think — we think we are in good shape, Nick. I think, look, obviously, a lot of interest in the market on the relativity of stock positions in General Merchandise retailers globally over the last period of time.
I would say that, one of the things that we have been very focused on as a team is the rigorous management of our stock. Making sure we have got real line of sight as to where it is, what’s on shore, what’s off dock, how we are prioritizing fast moving product within our range.
One of the features of our improvement in availability has been our improved processes and how we have been managing this across our logistics and supply chain and commercial teams. So, I think no complacency in anything I have said there.
Clearly we are pleased with our market share growth in General Merchandise, you can see through the first half how that’s built. That’s built off the back of both weakness in last year’s numbers, some improved weather, but importantly, structural improvements in how we are managing availability.
And of course, it’s one of the key points of focus for us to make sure that we are stocking effectively to our forward plan. And so as we look at, how we are trading, the momentum we have started the second half with, we think we are in solid shape here.
Nick Coulter
Are you kind of risk on or risk off? Are you, kind of being conservative and willing to miss sales or how are you approaching peak? How do you think the industry is set up for peak, because clearly Walmart and Target weren’t set up appropriately?
Simon Roberts
Yeah. Well, we think we are well set up for peak and I’d never over and be complacent about that. These are difficult times, as you say, but we are in a strong place. We have got stock where we need it. We are geared up for actually some of the unique characteristics of the pre-Christmas build. We have spoken about a World Cup coming just before Christmas. Obviously a Black Friday where customers are going to want to really buy into products this year and really get value and so all of our plans have taken into account the best view we can see. For obvious reasons, as you would expect me to say, what the top of customer demand is and what the bottom of that, we will find out over coming weeks, but we are well prepared for it.
Kevin O’Byrne
Yeah. And just to build on that…
Nick Coulter
And then…
Kevin O’Byrne
… point about the dollar. The – clearly, we don’t know if we have got it right and we will tell you after Christmas, but we are also mindful that there’s good stock and bad stock. And there’s some stock if we are buying it now and we have bought it on old dollar rates to come onto your next question.
Nick Coulter
Yeah.
Kevin O’Byrne
If we had to winter it and sell it later, that would be fine. There’s other stock that clearly deprecates…
Nick Coulter
Yeah.
Kevin O’Byrne
… in front of your eyes and you wouldn’t want lots of it around. So, we will play all that, as you can image. Just on the dollar hedge and no impact on the dollar, no impact for this year as you could imagine, because we will have bought forward.
For next year and more than half of the dollars we need for next year, we think we have bought and can’t tell you what the rate is, but you can imagine it’s comfortably above what is in the marketplace right now. And but…
Nick Coulter
Yeah.
Kevin O’Byrne
… another point it’s probably worth making, because I think, people assume that, if the dollar goes down that affects Argos profitability. It may affect Argos profitability but not in the way I think people think, because, clearly, it will affect the cost of the product, and therefore, it will affect the product – the cost that we are selling it at.
But like everyone in the market, we would have to adjust the pricing versus the dollar and if we are hedged a little bit better than others, than we can be more competitive for longer, so that’s good. But where it will affect, of course, is demand. So, as the dollar weakens and prices go up, it will affect demand.
The good news is that freight is going down, so that’s helpful in the marketplace and we are seeing where we had freight inflation we will have deflation in freight so that’s helpful. So, in the mix I think the real question will be what will it do to demand.
Nick Coulter
Yeah. No. I think that’s fair. Again, just a quick one on Nectar360, which looks like a real bright spot and sounds very encouraging. Are you able to share a profit figure for the half please or some sense of how you are going through that curve to the raised target?
Simon Roberts
Yeah. I mean, I would — as you know I am going to say, we don’t split out Nectar profitability specifically on its own, but to your first point, we are really encouraged with the progress on Nectar and Nectar360. As you have seen in the half, we have gone through our 10 million and first target for digital Nectar collectors.
And actually, the platform of Nectar360, we are really encouraged with how that’s building. I think, from a macro perspective, as we see the cost of advertising in the market really pick up, I think more and more is the opportunity to use Nectar360 as a way of directly reaching, in a personalized way, customers.
And so, you have seen that we have upgraded our expectations in terms of profitability over the next period of time and that’s just a function of the fact we are now working with over 700 suppliers. Momentum is really picking up, our team are doing a fantastic job in this area to really build out our capability.
Nick Coulter
Brilliant. No. Looks good. Thank you.
Simon Roberts
Thank you.
Operator
Our final question is from Victoria Petrova at Credit Suisse. Please unmute yourself and ask your question.
Victoria Petrova
Thank you very much
Simon Roberts
Hello, Victoria.
Victoria Petrova
I will be quick.
Kevin O’Byrne
Hello, Victoria.
Victoria Petrova
Hello. Hello. Thank you. My first question is if we look at your cost savings versus extra costs, is it fair to assume that you are saving around £250 million per annum this year and next year probably and are running at around £260 million, £275 million, maybe £280 million extra costs, with a similar split to your competitors, when we look at labor versus energy. Is it fair to assume, any comment would be extremely helpful. My second question is, do you expect underlying profit before tax to be up or down next year?
Simon Roberts
Look, I have tried to give.
Victoria Petrova
Thank you. It was a try.
Simon Roberts
No. It’s clear Victoria. Well, look, I hope we have given you as much clarity on the shape of our cost program. And I guess, just maybe before passing to Kevin, on the relative scale of our cost saving program compared to other listed retailers that have similarly put their cost saving target out. You can see the scale of what we are doing over three years at £1.3 billion compared to what we were doing before, more than twice the rate.
And that inflation is clearly higher in the business than we had before. But it’s the fact we have the cost saving opportunities in front of us still to go at, but we don’t think others have in the same way that we think is a very important underpin of the size of this cost ambition. I am not sure we can do a lot more to break it out in any more detail, but Kevin.
Kevin O’Byrne
It’s clearly more material, I think, Victoria, if I picked up your question right. It’s more than £400 million in the year.
Victoria Petrova
Thank you. That’s very helpful. Thank you very much.
Simon Roberts
Thanks, Victoria.
Kevin O’Byrne
Thanks, Victoria.
Simon Roberts
Okay. Well, look, if there are no…
Operator
That was our final question, so I will now hand back over to you, Simon, for closing remarks.
Simon Roberts
All right. Well, thank you. Thank you very much everyone this morning for joining us and I hope the presentation was useful. It’s been great to hear your questions this morning. Thank you for all your interest and we look forward to catching up with you over the next few weeks. Thanks again for your time. See you soon.
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