Shares in FTSE 100 supermarket J Sainsbury (LSE: SBRY) are down 10% from their 9 January 12-month high of £3.10. Such a drop in a solid top-tier company always flags to me the possibility of a bargain.
Whether it is depends on three things for me. First, why the shares have dropped and whether these reasons are likely to last. Second, if they are not, what is the firm’s earnings growth outlook? This ultimately powers a stock’s price higher (and its dividend too). And third, how undervalued are the shares right now?
What’s behind the price drop?
The slide in the Sainsbury’s share price started just after Christmas 2023 – a period covered by the Q3 trading statement.
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This looked good on the face of it, with grocery sales up 9.3% year on year. However, a closer look revealed that general merchandise sales dropped 0.6% and clothing sales fell 1.7%. Additionally negative for the market was no increase to the previous 2023-2024 profit guidance (albeit for £670m-£700m), in my view.
And the retailer’s performance this Christmas present a short-term risk for the stock price.
Another negative factor was Qatar Investment Authority’s 11 October announcement that it would sell 109.4m shares of its stake in the firm at £2.80 each.
No reason was given by either side for the sale, so whether more will be sold is anyone’s guess. This is another risk for the price.
A third part of the share price fall came, I feel, from concern over what would be in the Chancellor’s 30 October Budget. Sainsbury’s subsequently stated that it faces headwinds of £140m following the increase in employers’ National Insurance contributions.
Much of the negative impact of this will be passed on to customers, I believe. That said, the longer-term risk here is that higher prices cause a reduction in sales.
What’s the earnings growth outlook?
In its 7 February strategy update, the firm stated it would make £1bn of cost savings to 2027. It also targeted £1.6bn+ in free cash flow generated from its core retail operations by then. And it forecasts food volume growth ahead of the market.
Its H1 2024-2025 results released on 7 November showed retail sales up 3.1% year on year, to £16.3bn. Underlying operating profit rose 3.7% to £503m, and return on capital employed increased 0.6% to 8.5%.
Consensus analysts’ estimates are that Sainsbury’s earnings will grow 20.6% each year to the end of 2027.
How does the share price look now?
On the key price-to-book ratio stock valuation measure, Sainsbury’s currently trades at 0.9. This is bottom of its competitor group, so it looks undervalued on this basis.
The same applies to its price-to-sales valuation of 0.2 against a competitor average of 0.4.
A discounted cash flow analysis shows Sainsbury’s shares are 54% undervalued at their current £2.80. Therefore, a fair value for them is £6.09, although they may never reach that level, of course.
Will I buy the shares?
I am tempted by its strong earnings growth forecast. This should drive the share price and dividend higher over time in my view.
However, I have other high-growth shares that also deliver a yield of 8%+, so I will not be buying Sainsbury’s shares for the moment.
