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Are Banco Santander SA & J Sainsbury plc Good Companies In Bad Sectors?

A bad company in a bad sector is clearly one to avoid, because everything is against it. A bad company in a good sector is arguably worse, because it has no excuses. But a good company in a bad sector? That’s tricky. 

The Good Banker

Santander (LSE: BNC) has a double problem. The eurozone’s biggest bank is undoubtedly in a big, bad sector. Its problems are magnified because it is heavily exposed to Brazil, its second biggest market, which generates around one fifth of its earnings. The country is perilously close to sliding into outright depression, Goldman Sachs warns, as it fights inflation, a rising public deficit, plunging commodity prices, endemic corruption and political gridlock. Santander’s profits have been further hit by the fall in the Brazilian Real, and fears over rising loan impairments.

Things are better in Spain, its third biggest market, as the local economy picks up, with help from ECB monetary easing. The worry is that low interest rates are allowing zombie businesses and personal creditors to roll over unpayable debts, and defaults could soar when interest rates finally rise. The UK is now Santander’s biggest and most profitable market, thanks to the success of products such as the popular 123 current account, which won 960,000 customers in nine months.

Santander can hardly be described as a good bank, given that it announced a major fundraising and dividend cuts in January. It is also exposed to at least one bad sector, arguably two. There may still be good reasons to invest, however. Its valuation looks undemanding at 10.1 times earnings. The dividend may have been slashed earlier this year but it is forecast to yield 4.3% by the end of 2016. Earnings per share should rise a steady 5% next year. A good prospect, but not great.

The Good Grocer

The supermarket sector is bad for established players, although young bloods Aldi and Lidl are thriving. Tesco and MW Morrison have had very bad years, the latter dropping out of the FTSE 100. J Sainsbury (LSE: SBRY) has done better, aided by its relatively upmarket status. Its share price is actually up 5% this year, against a 13% drop at Tesco and 19% at Morrisons. 

In November, Sainsbury’s became the first major supermarket to increase market share for over a year. OK, it only increased share by 0.2 percentage points, lifting its market share to 16.6%, but that is a good performance in a bad environment. Sales grew 1.5%, and Sainsbury’s has high hopes for Christmas, where it traditionally does well, due to its focus on food. So there is hope that good could soon taste even better.

I always thought Sainsbury’s was unfairly hit by the supermarket sell-off. Its share price was stagnating even when it posted 36 consecutive quarters of sales growth. Yet I reckon UK groceries are still a bad place to be, given shifting shopping trends and the rise of the discounters. Sainsbury’s was forced to slash its dividend earlier this year, but is still on a forward yield of 4.4%. This is a bad sector, sadly, which outweighs much of the good at Sainsbury’s.

Personally, I prefer to buy good companies in good markets.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.