One Reason I Wouldn’t Buy J Sainsbury plc Today

Today I am explaining why J Sainsbury’s (LSE: SBRY) (NASDAQOTH: JSAIY.US) reputation as a stellar dividend selection is in severe jeopardy.

Dividend growth facing extinction?

Shrugging off the consequences of the 2008/2009 financial crisis on shoppers’ wallets, Sainsbury’s has been able to keep earnings rolling higher as shrewd brand and product development, coupled with massive investment in exciting new channels such as online, has allowed it to grab customers from its beleaguered rivals.

Sainsbury'sAnd against this backcloth the business has been able to keep dividend rises chugging along at a healthy compound annual growth rate of 5.1% since fiscal 2014.

But City analysts believe that earnings are likely to come under the kibosh from this year, as rising competition in the UK grocery space — and the consequent requirement for subsequent heavy discounting — heap significant pressure on the bottom line. Indeed, Sainsbury’s is anticipated to experience a 7% earnings fall in the year concluding March 2015, and a further 1% drop is pencilled in for next year.

As a result the supermarket’s proud record of dividend growth is expected to come to an abrupt end, and forecasters expect a 5% cut in the full-year payout to materialise during 2015, to 16.5p per share. And the business is forecast to keep the payout on hold during 2016 in the absence of any earnings recovery.

Estimated payments through to the end of next year still carry monumental yields of 5.3%, however, comfortably surpassing a forward reading of 3.2% for the FTSE 100, as well as a corresponding figure of 3.5% for the entire food and drug retailers sector.

Competition on the charge

But I believe that actual dividends for this year and next could fall short of even these disappointing projections given the meagre dividend cover on offer — indeed, payouts for 2015 and 2016 are protected just 1.7 times by earnings, uncomfortably below the generally-considered minimum safety reading of 2 times.

premierfoodsAnd the prospect of escalating earnings pressure could drive this meagre readout even lower as the competition raises the stakes. Although Sainsbury’s has fared better than mid-tier compatriots Tesco and Morrisons, who have seen market share consistently erode since the recession pushed shoppers into the arms of the discounters, the firm’s strong sales growth appears to have finally hit the skids.

As latest Kantar Worldpanel data showed, Sainsbury’s saw revenues creep just 1.2% higher during the 12 weeks to July 20. By comparison, Aldi and Lidl saw turnover surge 32.2% and 19.5% respectively.

With the country’s discount chains gearing up for aggressive expansion from this year onwards, along with premium stores such as Waitrose and Marks and Spencer, Sainsbury’s could see earnings fall off a cliff in the coming years. With this in mind the company’s history of offering terrific dividends could be on borrowed time.

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Royston Wild has no position in any shares mentioned. The Motley Fool owns shares in Tesco.