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Here’s why I reckon the Sainsbury’s share price could beat the FTSE 100

I was in one of J Sainsbury‘s (LSE: SBRY) stores yesterday, picking up a few IPAs to enjoy in the sun, and I wasn’t massively impressed. It was all a bit tatty and cluttered and tired. The staff were nice though.

Shine off

A quick glance at the Sainsbury’s share price shows a company that has lost its shine. After years of poor performance its stock even remains locked out of this year’s market recovery, down more than a quarter year-to-date, while the FTSE 100 is up 12%.

There is no doubt Sainsbury’s has a major challenge on its hands as squeezed consumers fall for those unshakeable insurgents, Aldi and Lidl. Sainsbury’s trades 40% lower than it did a full decade ago and even that understates the long-term natures of its decline, with the stock at a 30-year low.

Coupe de grâce

CEO Mike Coupe stands accused of being rewarded for failure, trousering a £3.9m pay packet despite the failure of his plan to merge with Asda, which was blocked by the Competition and Markets Authority (CMA) in April.

Still, Coupe has done something right, with underlying profits up 7.8% in the year to 31 March to £635m, net debt down £222m to £1.64bn, ahead of target, and the dividend up 7.8%. The Argos integration has delivered £160m in synergies, with 281 Argos stores in Sainsbury’s supermarkets at the year end and “physical points of presence” totalling 1,200.

Look at that yield

So what is the attraction of buying Sainsbury’s today? The most obvious is its generous dividend, currently 5.62%, against 4.44% for the FTSE 100 as a whole. Unlike some of today’s top dividend stocks, this one looks pretty safe. Sainsbury’s enjoys strong cash generation with retail free cash flow of £461m, up 6.7% in a year. Better still, management is maintaining cover at a comfortable two times earnings.

The group is also working to strengthen its balance sheet, with a new target to reduce net debt by at least £600m over the next three years. Sainsbury’s shares also look nicely priced, trading at around nine times forecast earnings, which compares to a relatively pricey P/E of 17.49 times earnings for the index as a whole.

So Sainsbury’s offers a more generous dividend, at roughly half the price of the index. What’s not to like?

Count the cost

Well, it still has a fight on its hands. As Stepan Lavrouk points out, the only way for Sainsbury’s to beat its rivals is to cut costs. That will prove tricky.

As I discovered on my recent visit, it needs to give shoppers a brighter, tidier experience. Management has got the message, and is investing to improve more than 400 supermarkets this year.

Sainsbury’s is still the UK’s second biggest supermarket, but its market share has been steadily sliding and now stands at 15.2%, level pegging with Asda. So it could suffer the morale blow of falling into third place at any moment. Sainsbury’s looks more tempting than it has for some time, but sustainable growth still looks a distant prospect. You may prefer to check out these high yielding FTSE 100 stocks instead.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.