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What Dividend Hunters Need To Know About J Sainsbury plc

Today I am looking at whether J Sainsbury (LSE: SBRY) is an appealing pick for those seeking chunky dividend income.

Beware the rise of the budgeteers

Robust earnings growth during the past five years has enabled British grocery institution J Sainsbury to implement generous annual dividend hikes. The supermarket has raised payouts at an inflation-smashing compound annual growth rate of 6.1% dating back to 2009, making it a favourite among income seekers.

But potential investors should be aware of the impact of an increasingly splintered grocery market on Sainsburys’ earnings sainsbury'spotential in coming years, and with it the prospect of further dividend growth. Latest Kantar Worldpanel statistics revealed that Sainsbury’s market share slid to 16.5% in the 12 weeks to March 30, down from 16.9% last year. Meanwhile Lidl and Aldi saw their cuts rise to 3.4% and 4.6% respectively, up 0.5% and 1.2% from corresponding 2013 period.

City analysts expect Sainsbury’s to punch earnings growth of 4% in the 12 months concluding March 2015, the slowest expansion rate for many years and which is likely to lead to a more modest 4.2% rise in the full-year dividend to 17.4p per share.

And forecasts expect a modest payout cut to transpire in 2016, with a 4% earnings slip leading to a 4% decline in the total payment to 16.7p. Still, these payments create chunky yields of 5.4% and 5.2% respectively, comfortably surpassing a forward average of 5.2% for the complete FTSE 100.

An uncertain long-term dividend outlook

But the aggressive expansion plans of the budget retailers puts long-term dividend growth in significant jeopardy, in my opinion. And should current earnings forecasts miss, prospective payouts could also underwhelm in the meantime — Sainsbury’s carries dividend coverage of 1.8 times prospective earnings through to the end of next year, just below the safety threshold of 2 times but which could significantly deteriorate should Lidl et al maintain the blistering pace of recent years.

I have long argued that Sainsbury’s is the best-placed operator in the mid-tier supermarket space, with heavy investment in brand development and expansion of its convenience and online operations helping it to fare much better than the likes of Tesco and Morrisons.

But as competition in the UK grocery space intensifies, Sainsbury’s may be forced to continue dedicating vast swathes of capital into such areas to stay ahead of the game. With sales also in line to come under increasing pressure, dividend growth is in danger of further heavy shrinkage in coming years.

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Royston does not own shares in any of the companies mentioned in this article. The Motley Fool owns shares in Tesco and has recommended shares in Morrisons.