How Safe Is Your Money In J Sainsbury plc?

When Justin King, the outgoing chief executive of J Sainsbury (LSE: SBRY) (NASDAQOTH: JSAIY.US), announced his resignation at the end of January, I was fairly sure he knew the firm’s nine-year run of sales growth was coming to an end.

Today’s news that Sainsbury’s sales finally turned south and fell by 3.8% during the fourth quarter didn’t surprise anyone, but the question for long-term shareholders is whether there is worse to come.

I’ve been taking a closer look at Sainsbury’s finances to see if there are any warning signs that the firm’s prized dividend could come under threat as sales fall.

1. Operating profit/interest

What we’re looking for here is a ratio of at least 1.5, preferably over 2, to show that Sainsbury’s earnings cover its interest payments with room to spare:

Operating profit / net finance costs

£920m / £123m = 7.5 times cover

Sainsbury’s falling share price has driven its dividend yield up to 5.4%, but the firm’s finance costs have been covered 7.5 times by its operating profits over the last twelve months, suggesting that the dividend remains safe, despite slowing sales.

2. Debt/equity ratio

Commonly referred to as gearing, this is simply the ratio of debt to shareholder equity, or book value. I tend to use net debt, as companies often maintain large cash balances that can be used to reduce debt if necessary.

sainsbury'sIn its most recent accounts, Sainsbury reported net debt of £2.2bn and equity of £5.8bn, giving net gearing of 39%. This is fairly conservative, for a large company, and is considerably lower than either Tesco (52%) or Wm. Morrison Supermarkets (59%).

3. Operating profit/sales

This ratio is usually known as operating margin and is useful measure of a company’s profitability. Sainsbury’s biggest weakness has always been its below-average profit margins — so has anything changed?

Using Sainsbury’s figures from the last twelve months, I’ve calculated its current operating margin to be 3.9%. This is lower than the 5% figure historically targeted by Tesco and Morrisons, but both of these have reported significantly lower profit margins over the last year, and this trend is likely to continue, as a new supermarket price war seems likely.

In my view, the test for Sainsburys could be whether it’s forced to go head-to-head with Aldi and Lidl, or whether it is able to profit from its more upmarket image and avoid such heavy discounting. 

Is Sainsburys a safe buy?

Sainsbury's finances look solid, but I'm not sure that Sainsbury is the best way to play the UK supermarket sector. That's an opinion shared by the Motley Fool's own retail analysts, who recently selected a different supermarket for their exclusive new wealth report, "The Motley Fool's Five Shares To Retire On".

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Roland owns shares in Tesco and Wm. Morrison Supermarkets, but does not own shares in J Sainsbury. The Motley Fool owns shares in Tesco and has recommended shares in Morrisons.