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A Practical Analysis Of J Sainsbury Plc’s Dividend

The ability to calculate the reliability of dividends is absolutely crucial for investors, not only for evaluating the income generated from your portfolio, but also to avoid a share-price collapse from stocks where payouts are slashed.

There are a variety of ways to judge future dividends, and today I am looking at J Sainsbury (LSE: SBRY) (NASDAQOTH: JSAIY.US) to see whether the firm looks a safe bet to produce dependable payouts.

Forward dividend cover

Forward dividend cover is one of the most simple ways to evaluate future payouts, as the ratio reveals how many times the projected dividend per share is covered by earnings per share. It can be calculated using the following formula:

Forward earnings per share ÷ forward dividend per share

Sainsbury is expected to deliver a dividend of 17.3p per share for the year ending March 2014, according to City analysts. With forward earnings per share pencilled in at 31.8p, the potential payout is covered 1.8 times, just below the safety benchmark of 2 times prospective earnings. The board has stated its aim to build this closer towards 2 times cover, however.

Free cash flow

Free cash flow is essentially how much cash has been generated after all costs and can often differ from reported profits. Theoretically, a company generating shedloads of cash is in a better position to reward stakeholders with plump dividends. The figure can be calculated by the following calculation:

Operating profit + depreciation & amortisation – tax – capital expenditure – working capital increase

The supermarket giant generated positive free cash flow of £164m in 2013, swinging from negative free cash flow of £15m in the prior 12-month period. The improvement was predominantly down to a chunky reduction in capital expenditure, to £1.04bn from £1.24bn in 2012, as the firm scaled back its new store opening and expansion programme from prior years.

Financial gearing

This ratio is used to gauge the level debt a company carries. Simply put, the higher the amount, the more difficult it may be to generate lucrative dividends for shareholders. It can be calculated using the following calculation:

Short- and long-term debts + pension liabilities – cash & cash equivalents

___________________________________________________________            x 100

                                      Shareholder funds

Sainsbury saw financial gearing edge up to 37.7% last year from 35.2% in 2012, mainly owing to a meaty increase in net debt during the period. This rose to £2.16bn in 2013 from £1.98bn in the previous year, owing to a multitude of factors including higher tax, lower cash balances and lower sale and leaseback proceeds. City analysts expect gearing to continue heading higher.

Buybacks and other spare cash

Here, I’m looking at the amount of cash recently spent on share buybacks, repayments of debt and other activities that suggest the company may in future have more cash to spend on dividends.

Sainsbury said that it expects core capital expenditure, excluding investment pertaining to Sainsbury’s Bank — in which it has agreed to purchase the remaining 50% from Lloyds for £248m — to clock in at £1.1bn in the current year, up fractionally from 2013.

The company is tipped to continue opening new stores, as its position is still to mature in many geographical locations. More money is also tipped to flow into IT, logistics, and new convenience store openings.

Still, the company does not engage in share buyback activity, while its debt pile is expected to keep heading higher. Including considerations related to the purchase of the remaining stake in Sainsbury’s Bank, the company anticipates net debt rising to £2.6bn in 2014.

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Sainsbury’s has an excellent track record of consistent dividend hikes dating back a number of years, and last year’s 16.7p full-year payout represented a near-4% increase from 2012 levels.

Sainsbury’s prospective dividend for 2014 carries a yield of 4.9%, outstripping the FTSE 100 average of 3.3%. With earnings expected to continue ticking up during the medium term, I expect dividends to similarly continue marching higher during the period. And I anticipate solid capex spend to drive earnings, and thus shareholder payouts, higher over the long term.

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> Royston does not own shares in J Sainsbury.