This Is Why I’d Sell J Sainsbury plc Today

J Sainsbury plc (LON:SBRY) has delivered impressive growth recently, but Roland Head is concerned about its underlying profitability.

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Since June 1 2012, shares in J Sainsbury (LSE: SBRY) (NASDAQOTH: JSAIY.US) have risen by 32%, outperforming the FTSE 100 by 11%. As a result, Sainsbury’s shares have lost their bargain status and are now beginning to look a little too expensive, in my view.

I believe that Sainsbury’s outperformance may be about to slow as Tesco’s recovery plans begin to take effect, and Morrison’s greater value and higher profit margins encourage investors to switch away from Sainsbury.

Long-term Sainsbury shareholders may not be concerned by this, and can continue to bank their dividends — but if you bought Sainsbury shares with an eye to capital gains, you may wish to think about locking in some profits.

Price matters

In its final results, which were published in May, Sainsbury reported that ‘price perception continues to improve’ — a reference to Sainsbury’s historical reputation for being more expensive than Tesco and Morrisons.

Unfortunately, price matters for investors as well as customers, and that’s where Sainsbury is doing less well. The supermarket currently trades on a 2013/4 forecast P/E of 12.5, compared to 11.3 for Tesco and 11.4 for Morrisons.

Sainsbury no longer offers a notably high dividend yield, either — its prospective yield is 4.4%, compared to 4.1% for Tesco and 4.3% for Morrison.

Low operating margins

Sainsbury could justify a higher valuation if it was slightly more profitable than its two direct competitors. Unfortunately, Sainsbury has a long history of being less profitable than Tesco and Morrison.

Sainsbury’s operating margin last year was 3.8%, in-line with its five-year average of 3.78%. Tesco’s operating margin fell to 3.4% last year, but its five-year average is 5.6%, while that of Morrison is 5.3%.

Supermarket margins are very narrow, and every little helps. For Sainsbury, a 0.1% fall in operating margin equates to a fall in operating profit of around 2.5% — or about £24m.

Investors need to ask why Sainsbury is so much less profitable than Tesco or Morrison, and whether Sainsbury’s recent market share gains are being achieved at the cost of cutting its already thin profit margins.

What’s next?

Sainsbury has delivered 34 quarters of like-for-like growth, during which time its market share has risen to 16.8%.

This is an impressive achievement, especially given the growth of Waitrose, Marks & Spencer, Aldi and Lidl, but my concern is that Sainsbury’s fragile margins could make its current growth hard to maintain.

An alternative to Sainsbury

If you’ve already banked a profit on your Sainsbury shares, you may be looking for blue chip stocks that currently look cheap.

Buying such companies has worked well for top UK fund manager Neil Woodford (who recently purchased shares in Morrisons). If you’d invested £10,000 into Mr Woodford’s High Income fund in 1988, it would have been worth £193,000 at the end of 2012 — a 1,830% increase!

If you’d like access to an exclusive Fool report about Neil Woodford’s eight largest holdings, then I recommend you click here to download this free report today.

> Roland owns shares in Tesco but does not own shares in any of the other companies mentioned in this article.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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