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3 Reasons I’d Sell Greggs plc And Buy J Sainsbury plc

Photo credit: Elliott Brown. Licence: https://creativecommons.org/licenses/by/2.0/

High-street baker Greggs (LSE: GRG) has undoubtedly been a superb investment over the last year. The shares have risen by 130% and Greggs has managed to deliver real growth while remaining debt-free.

But even the best companies are only good investments at the right price, and I reckon Greggs is beginning to look a bit pricey.

A supermarket alternative?

In this article, I’ll explain why I think it could be a good time to invest in a less popular stock — J Sainsbury (LSE: SBRY) (NASDAQOTH: JSAIY.US).

1. Low expectations, low price

The big supermarkets are certainly under pressure, slashing prices and profits in a price war that’s being driven by the success of Aldi and Lidl. Yet Sainsbury is doing better than expected.

It’s recorded a modest decline in sales, which fell 2.1% during the first quarter of this year, for example. Yet when the effects of price cuts are stripped out, this suggests to me that Sainsbury’s customers are remaining loyal to the store.

The firm’s formula of superior quality own brand goods at a slightly higher price appears to be working, for now at least.

Sainsbury currently trades on 12 times forecast earnings, with earnings expected to remain flat in 2016/17. These forecasts suggest expectations are low, opening the door to gains if Sainsbury does manage to outperform.

In contrast, my view of Greggs’ is that a 2016 forecast P/E of 22 suggests this stock is already priced to perfection. Earnings per share growth is expected to fall from 17% in 2015 to just 7% in 2016.

I don’t see the logic in buying Greggs now and would reduce the size of my holding if I was a shareholder.

2. The Sainsbury discount

Sainsbury’s forecast P/E of 12 puts it at a notable discount to Tesco and Wm Morrison Supermarkets, as these figures show:

Supermarket

2016 forecast P/E

Price/book ratio

Sainsbury

12.5

0.9

Morrison

16.4

1.2

Tesco

23.7

2.4

Why is this? Tesco may have some long-term advantages, as the largest supermarket in the UK, but I can’t see a good reason for Sainsbury to be this much cheaper than its peers.

One possible explanation is the fact that Sainsbury and Morrison are the most heavily-shorted stocks in the FTSE 100. More than 15% of each firm’s stock is on loan to shorters, according to financial information service Markit.

As long ago as last October, Sainsbury was the most shorted stock in the index. This will have helped to push down its share price, but could trigger gains if the shorts decide to lock in some profits, as they’ll need to buy shares to reduce their short positions.

Of course, it’s worth remembering that the shorters could be proved right. Supermarkets could have further to fall.

3. Income attractions

The final point in favour of Sainsbury is that despite cutting its dividend, it offers an attractive 3.5% prospective yield. That’s significantly higher than Greggs’ prospective yield of 2.2%.

While Greggs does have the advantage of net cash and no debt, Sainsbury has lower gearing than Tesco or Morrison, and I don’t see its debt levels as a major concern.

Greggs or Sainsbury?

Ultimately, it’s your choice. Growth and momentum investors will probably stick with Greggs, while value hunters might be more tempted by Sainsbury’s shares, which currently trade slightly below their net tangible asset value, a classic value buy signal.

In either case, I'd urge you to read "3 Hidden Factors Behind This Daring E-commerce Play" before you make any trading decisions on UK retailers.

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Roland Head owns shares of Wm Morrison Supermarkets and Tesco. The Motley Fool UK owns shares in Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.