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Watch out! FTSE 100 stock Sainsbury’s could be about to cut the dividend

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Unable to repel the attack on its customer base from all sides, I believe that J Sainsbury (LSE: SBRY) is a share that investors should cut adrift as soon as possible.

The impact of the so-called discounters on the ‘Big Four’ supermarkets has been well documented — indeed, I touched upon this theme last time I covered the share in April. Recent data from research house Kantar Worldpanel has unsurprisingly showed further slippage in J Sainsbury’s market share.

But the evidence is mounting that the London-based supermarket is beginning to struggle against its established rivals too. Kantar advised in recent days that whilst Tesco, Morrisons and Asda all saw revenues rise in the 12 weeks to June 17, those of Sainsbury’s continued to head south.

Merger buzz

Despite the steady stream of bad data, however, the FTSE 100 firm’s share price has flipped higher in recent times and gained 35% in value over the past three months alone. This is despite recent news in which it advised that like-for-like sales (excluding fuel) rose fractionally in the 12 weeks to June 30, up just 0.2%. This reading was also down from growth of 0.9% in the previous quarter and 1.1% in the three months before that.

Sainsbury’s has marched higher amid expectations amongst many that the tie-up with Asda announced in April — a union that will create the largest supermarket group in the UK — will transform the company’s fortunes.

I think recent buyers of the grocer’s stock could be setting themselves up for a fall here. First thing’s first: the deal may well even fail to leap over the first hurdle if the Competition and Markets Authority says no.

Should the companies get the regulatory go-ahead and put in action the economies of scale needed to bring down costs for the customer, the market still remains ultra-competitive, and the expansion of Aldi and Lidl, the possible entry of Amazon, and the impact of a rejuvenated Tesco, means that the move may ultimately end up being an expensive folly.

Asda, like Sainsbury’s, has also been failing in recent years. So expecting the bolting-together of these entities to be a roaring success is stretching it a little, in my opinion.

Dividend on the block?

Whilst Sainsbury’s has suggested that the enlarged company would be “highly cash generative,” with any deal likely to take many, many months to complete I think the business is in danger of serving up yet another dividend cut in the meantime.

The supermarket has slashed the payout three times in the past five years, of course, and while it kept the dividend on hold at 10.2p per share in fiscal 2018, I reckon another reduction could be around the corner.

The 1% earnings improvement forecast by the City for the current period means that a projected 10.6p per share reward (yielding 3.2%) is covered by profits a robust 1.9 times. However, the scale of J Sainsbury’s net debt pile, which stood at a mountainous £1.36bn as of March does not leave much wiggle room should the downward sales momentum continue and profits forecasts thus disappoint.

At the current time Sainsbury’s carries a forward P/E ratio of 16 times. I would consider a figure close to the bargain watermark of 10 times to be a fairer reflection of the company’s high risk profile. What’s more, given the supermarket’s heady share price ascent of recent weeks, I reckon such a valuation leaves it in danger of a painful retracement should trading numbers, as I predict, fail to improve.

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Royston Wild has no position in any of the shares mentioned. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.