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Is Sainsbury’s share price now the biggest bargain in the FTSE 100?

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There’s no way to avoid the fact that J Sainsbury (LSE: SBRY) has been a disappointing investment for many years. The shares are trading close to all-time lows and a planned merger with Asda is in doubt. Today, I want to ask whether investors should be buying the supermarket giant’s stock or shopping elsewhere.

Why are things so bad?

Sainsbury’s share price is 40% lower today than it was 24 years ago, at the start of 1995. Over the same period, the FTSE 100 has risen by 144% and shares in Tesco have doubled, despite the group’s problems in recent years.

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One problem for the orange-topped supermarket is that it doesn’t have the scale of Tesco or the food production business of Morrison. Both help to support higher profit margins and returns on capital employed.

Supermarket

Operating profit margin

Return on capital employed

Tesco

2.9%

6.5%

Morrisons

2.1%

5.7%

Sainsbury’s

1.3%

3.3%

As you can see, Sainsbury’s is much less profitable than its two listed rivals. The group’s return on capital employed figure tells us that capital invested in the business generated a return of just 3.3% last year. With such low returns, improving the profitability of the business needs to be CEO Mike Coupe’s top priority, in my view.

Coupe’s big idea for solving this problem is to merge with Asda. Together, the pair would be a similar size to market leader Tesco. This should result in cost savings on purchasing, distribution and warehousing.

However, significant numbers of store closures are expected to be needed if the CMA does approve the deal, which currently seems unlikely. And combining two large supermarket chains while trading under two brands with two store networks will be a big, complex project.

Sainsbury’s shares may look cheap, with a 4.5% dividend yield and a forecast price/earnings ratio of 11. But the group has only just finished integrating the Argos merger and is already desperate for another deal.

I’m not convinced by this strategy. I think Sainsbury’s needs to find a way to improve the performance of its existing business instead. I’d rate the shares as a hold, at best.

Should I buy M&S instead?

Many of the same criticisms which apply to Sainsbury’s could be applied to Marks and Spencer Group (LSE: MKS). Sales have flatlined at the high street stalwart in recent years and profits have fallen sharply.

The recent £750m deal with Ocado to set up a home delivery joint venture looks expensive at first glance, as I discussed here. It will also require shareholders to stump up £600m of new cash in a rights issue.

Despite these concerns, I believe this situation is different to Sainsbury’s. Marks & Spencer’s management team has a clear strategy to reshape and reduce its store portfolio, update its product ranges and expand its online presence.

Although the Ocado deal might seem expensive, if it’s successful I think it could prove to be a long-term driver of growth. A sophisticated online food and clothing offer could help M&S redefine itself for the 21st century.

This is a big ambitious plan and success isn’t guaranteed. But I would be much more comfortable investing here than in Sainsbury’s.

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Roland Head owns shares of Tesco. 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.

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