For me, the main reason for investing in a supermarket such as J Sainsbury (LSE: SBRY) is to harvest shareholder dividends. So does Sainsbury’s share price near 262p make the stock a bargain?
Maybe. By some measures the current level of the shares assigns an undemanding valuation to the business. For example, the forward-looking price-to-earnings multiple is around 13 for the trading year to March 2024. And the anticipated dividend yield that year is about 4.6%.
Points to consider
However, several factors keep me wary of the company. And the first is that City analysts predict declines in both earnings and dividends for the current year to 5 March and the year following. And one thing I aim for with dividend investments is a record of revenue, earnings, cash flow and dividends that tend to rise a bit each year. So Sainsbury fails that test.
A second factor keeping me away from the stock is that Sainsbury carries a lot of debt. My data provider has the Market capitalisation at £6.1bn and the enterprise value at £11.27bn. And the difference between the two represents an approximation of net borrowings.
In the past, supermarkets could justify big borrowings by pointing to the steady and defensive nature of their businesses. Cash often used to keep rolling in no matter what the general economic conditions. But nowadays, I don’t think the situation is that simple.
There’s a lot of cutthroat competition out there for the big supermarket chains. But Sainsbury doesn’t have the financial safety cushion of big profit margins. The supermarket game is well known for its huge volumes and low profits. And that’s a business model that can work well. But it has the potential to break down when the market becomes over-supplied. And consumers today have plenty of choice about where they can shop.
Strong revenue
All of that means that Sainsbury’s profits and dividends may be fragile. So the declines in those two indicators are unwelcome and may be something of a warning sign. But in fairness, Sainsbury posted a decent set of figures in January for revenue.
The firm’s sales performance for the three months to 7 January built on earlier gains. And that led to a decent revenue outcome at the three-quarter point of the trading year. However, costs such as rising staff wages affected profits. But the rate of rising costs may moderate ahead. And the company’s earnings may improve over time.
Nevertheless, I’ve always had a rule for myself not to invest in any supermarket stock unless the dividend yield is at least 5%. And that’s because I’d have better compensation for the risks of holding the shares at that level.
But avoiding Sainsbury now could be a mistake. The share price has been buoyant lately. And there is some speculation the company could become a takeover target. For example, in January the directors announced that Bestway Group had acquired shares representing a 3.45% stake in the company. But Bestway denied that it’s considering an offer for the business.
It’s possible others could pitch for the company, But on balance, Sainsbury isn’t a no-brainer stock for me to buy right now.
