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The Stock Picker’s Guide To J Sainsbury Plc

Successful investors use a disciplined approach to picking stocks, and checklists can be a great way to make sure you’ve covered all the bases.

In this series I’m subjecting companies to scrutiny under five headings: prospects, performance, management, safety and valuation.How does Sainsbury’s (LSE: SBRY) (NASDAQOTH: JSAIY.US) measure up?

1. Prospects

The UK grocery sector is mature and stagnant, particularly in the face of tightened consumer spending. While traditional outlets are seeing weakening sales, there is significant growth online and in convenience store, where Sainsbury’s has a decent position and is continuing to invest.

Sainsbury’s 16.5% UK grocery market share is about half that of market leader Tesco. The supermarket recently bought out its joint-venture partner in Sainsbury’s Bank, valuable for customer loyalty and data mining.

2. Performance

Traditionally with a more upmarket image than its rivals, Sainsbury’s has weathered the recession well with a big push into own-label products. It recently announced its 33rd consecutive quarterly like-for-like sales growth.

However, Sainsbury’s margins are weaker than competitors. Operating margins have been around 3.5% against 5% for Tesco and Morrisons, with return on capital around 10% compared to 12% and 15% for the others.

Shareholders have seen an increasing dividend for the last eight years, with cover around 1.7 times.

3. Management

Justin King is widely anticipated to step down next year, when he will have been CEO for ten years. An outspoken industry voice, he has restored Sainsbury’s fortunes but his departure is so well anticipated that management succession should not be a problem.

4. Safety

Sainsbury’s has moderate net gearing of 40%, with interest covered over five times. Typical of supermarkets, cash sales means it has negative working capital.

The shares are only 30% higher than tangible book value ignoring property revaluations, and a £0.7bn pension deficit is manageable.

Despite three years of £1bn-a-year capital expenditure as convenience stores are rolled out, Sainsbury’s free cash flow has covered its fixed costs and dividends.  Capex is expected to trim down in three to five years time.

5. Valuation

On a prospective P/E of 12.4, Sainsbury’s is at a premium to Tesco (11.7) and Morrisons (11.2) with a yield at 4.5% roughly on a par. Market share gains over the past 12 months have boosted the shares compared to turning-around Tesco and catching-up Morrison.

Conclusion

For long-term investors, selecting between the supermarkets is pretty much a question of taste, much like choosing where to shop. In a mature but defensive sector, they are most appealing for their dividend.

That’s one reason that the Motley Fool’s pick of the best five shares to form the cornerstone of a portfolio includes a supermarket.  The five companies are all in different sectors and each have dominant market positions, healthy balance sheets and robust cash flows to underpin their future dividends.

You can find out which the companies are by clicking here to download an exclusive report — it’s free.

> Both Tony and The Motley Fool own shares in Tesco but no other shares mentioned in this article.