Should I buy Sainsbury’s shares to boost my passive income?

Sainsbury’s shares offer some of the biggest dividend yields on the FTSE 100 today. But can I rely on it to provide a long-term second income?

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Supermarket shares are usually hot property when times get tough. Yet the Sainsbury’s (LSE: SBRY) share price has fallen 19% since the beginning of 2022.

Pleasingly, this means Sainsbury’s shares continue to offer market-beating dividend yields. For this financial year (to March 2023), the grocer’s yield sits at 5.6%, way above the 3.7% FTSE index average. And the yield remains elevated at 5.3% for next year too.

But how robust do current dividend projections look? And should I buy the FTSE 100 retailer for my portfolio anyway?

Dividend shrinkage

Traditionally speaking, supermarket revenues tend to remain broadly stable at all points of the economic cycle. It’s what has encouraged Sainsbury’s to remain a generous dividend payer, despite the uncertain UK outlook.

Last year it hiked the annual dividend 24% to 13.1p per share. The year before that it also retroactively paid a special dividend. This was to compensate for a lack of shareholder payouts at the height of the Covid-19 crisis.

However, City analysts expect the business to steadily reduce dividends over the medium term. Rewards of 12.5p and 11.9p per share are forecast for financial 2023 and 2024 respectively.

Unrealistic forecasts?

The good news is that dividend predictions still create those market-beating yields. The bad news is that these forecasts look (to me at least) a little too large.

Brokers think the supermarket’s earnings will drop 16% this year and 4% next year. Therefore dividend coverage sits at 1.6 times to 1.7 times over the period, below the company’s desired target of 1.9 times.

The retailer’s weak balance sheet also casts a shadow over the City’s dividend forecasts. Net debt dropped £180m year on year between April and September. But it still stood at an eye-popping £6.2bn, giving the business little wriggle room to pay predicted dividends if earnings miss.

The verdict

So I wouldn’t buy Sainsbury’s shares to boost my dividend income. In fact, I think payouts could continue shrinking beyond the medium term as earnings pressure increases.

Britain’s traditional supermarkets are losing business at an astonishing pace to discount chains. Even profit-crushing price slashing is failing to stop the bloodletting. The market share at Sainsbury’s, for instance, has fallen 1.7% over the past decade, according to Kantar Worldpanel.

This, along with the problem of rising costs, has pulled the Sainsbury’s share price lower this year. And things look set to get worse for the established chains.

Heavy investment into e-commerce provides a potential area for the supermarket to boost earnings. Online grocery has lagged the rest of internet retail in recent years, providing excellent scope for growth.

But the rapid expansion of German chains Aldi and Lidl could still keep profits under severe pressure. Aldi alone is hoping to open more than 200 more stores by 2025, taking the total to 1,200.

So forget about Sainsbury’s shares. I’d much rather buy other dividend stocks to boost my passive income.

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.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Sainsbury (J). Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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