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Is Now The Right Time To Buy J Sainsbury plc?

Sainsbury'sAlthough J Sainsbury (LSE: SBRY) (NASDAQOTH: JSAIY.US) hasn’t attracted the scathing criticism dished out to Tesco and Wm. Morrison Supermarkets over the last year, it’s not escaped unscathed.

Indeed, I think that Sainsbury’s long-standing chief executive, Justin King, stepped aside at just the right moment — ahead of an expected downturn in the supermarket’s profits over the next couple of years.

Sainsbury’s share price has now fallen by 28% from its 52-week high of 428p — so is now a good time to buy?

Valuation

Let’s start with the basics: how is Sainsbury valued against its historic and forecast earnings?

P/E ratio Current value
P/E using 5-year average adjusted earnings per share 10.8
2-year average forecast P/E 10.4

Source: Company reports, consensus forecasts

Based on these figures, Sainsbury looks very reasonably priced at the moment, although it’s noticeable that the firm’s forecast P/E is slightly lower, highlighting the market’s expectations for a fall in earnings this year.

What about the fundamentals?

Sainsbury’s sales, profits and dividend payments have all grown steadily over the last five years, as these figures show:

Financial summary 5-year compound average growth rate
Sales 4.2%
Underlying pre-tax profit 5.5%
Adjusted earnings per  share 6.5%
Dividend 4.0%

Source: Company reports

However, it’s worth noting that these apparently solid profits have not translated into free cash flow, thanks to the firm’s heavy investment in new stores.

Last year, for example, the Sainsbury’s net debt rose by £222m, once the cash acquired with Sainsbury’s Bank was stripped out. This means that the majority of last year’s £320m dividend payment was effectively funded by borrowing, as it was in 2012/13.

Given this, perhaps it’s not surprising that consensus forecasts currently suggest that Sainsbury’s dividend could fall by around 4.5% this year, to 16.5p.

Buy or sell?

Unlike Tesco and Morrison, Sainsbury looks reasonably healthy and has not suffered the dramatic slides in sales seen at the other two firms. On the face of it, now would be a great time to buy.

There’s only one risk.

Morrison’s sales have slumped, and the firm is busy slashing prices. Tesco’s sales are also down, and I expect the firm’s new CEO, Dave Lewis, to follow Morrison’s example, and kick off a price war this autumn.

Sainsbury’s seems to have escaped so far, but it may simply be the last to arrive at the party. This could be a problem, as Sainsbury’s profit margins are already lower than those of Morrison and Tesco, giving the more upmarket firm less room to manoeuvre on price.

I think the risks are evenly balanced for Sainsbury, and rate the supermarket as a hold. However, I don’t think the firm is the best opportunity in today’s market — far from it, in fact.

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Roland Head owns shares in Wm. Morrison Supermarkets and Tesco. The Motley Fool UK owns shares in Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.