Will J Sainsbury plc Become A Value Trap Like Tesco PLC?

Everyone loves a bargain, needless to say, particularly when it appears that the wider market may have missed a trick. But savvy investors should be aware that even the best can be drawn into so-called ‘value traps’ and suffer a severe hit in the pocket.

Billionaire and veteran trader Warren Buffett famously got his own fingers burnt when he tried to cash in on Tesco‘s (LSE: TSCO) price collapse back in January 2012 following its shock profit warning. With the firm seemingly lacking what it takes to recover from this setback and take the fight to the competition, Buffett finally slashed his holding in the firm in October and described his decision to stock up in 2012 as a “huge mistake.”

With this in mind, I am looking at why investors should be wary of trying to make the most of share price weakness at J Sainsbury (LSE: SBRY).

A great value pick on paper

At first glance, Sainsbury’s may appear to be a delicious stock pick for income and dividend hunters.

Based on current City estimates, the supermarket changes hands on a P/E rating of just 9.2 times prospective earnings for the year concluding March 2015, below the benchmark of 10 times that represents stunning value for money. And although this rises to 10.6 times for fiscal 2016 this remains an attractive proposition.

And even though enduring top-line turmoil is expected to weigh heavily on the dividend, Sainsbury’s is predicted to keep churning out above-average payout yields.

With the firm warning last month that this year’s dividend is likely to be below 2014 levels, the number crunchers anticipate an colossal 23% reduction in the payout to 13.4p per share. And an additional 16% reduction is pencilled in for fiscal 2016, to 11.3p.

But these payments still produce stonking yields of 5.7% and 4.8% respectively. By comparison, the FTSE 100 boasts a forward average of 3.2%.

… but trading pressures could smash projections

But like Tesco, I believe that the London-headquartered business could be in danger of significant broker downgrades in light of worsening industry pressures. Indeed, Sainsbury’s is expected to follow a 19% earnings slide this year with another 12% drop in 2016, indicating the hard slog that the business has ahead of it.

The relentless march of the discounters like Lidl and Aldi is likely to worsen as they embark on their steroid-pumped expansion plans. In a bid to match these chains, Sainsbury’s has vowed to match prices at mid-tier rival Asda. But not only does this scheme remain uncompetitive compared with the budget chains, but these expensive measures are also hammering margins.

In fairness, Sainsbury’s is taking other measures to mitigate its eroding falling share, particularly through the expansion of its online and convenience store operations. But these areas are also ultra-competitive and do not promise to deliver riches over the long-term.

Sainsbury’s has shown more savvy than its industry rivals in taking on the discounters, exemplified by its own entry into the segment by reintroducing Netto to the UK. But as shoppers continue to vote with their feet and leave the traditional retailers in droves, the business could see earnings and thus dividend prospects deteriorate sharply in coming years.

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