It’s difficult for me to find any reason to buy the J Sainsbury (LSE: SBRY) share price right now. Even though shares in the retailer are currently trading at one of the lowest valuations in the past decade, and the lowest valuation of the sector, the group’s bleak growth outlook is a major concern.
Indeed, City analysts expect the company’s earnings per share will fall 15% this year. On the other hand, analysts have pencilled in earnings growth of 5% and 25% for Sainsbury’s largest peers, Tesco and Morrisons, respectively.
It looks as if the company is closing in on analysts’ dismal expectations for the year. Sainsbury’s like-for-like sales for 16 weeks to the end of June were down 1.6%, excluding fuel, which tells me the business is struggling to compete in the current retail environment. And now that the group’s merger with Asda has been scrapped, it’s difficult to see what the future holds for this retailer.
Management needs to pull something out of the hat to return the business to growth and draw customers back into Sainsbury’s store. Until there’s some progress on this front, I’m not tempted by the firm’s low valuation and a 1.5% dividend yield.
A better buy
In my opinion, a better retail sector buy is the convenience store operator McColl’s Retail (LSE: MCLS). Even though it has its own problems, McColl’s has a plan. For the past two years, the group’s operations have been disrupted by supply chain issues, which caused profits to drop 50% in 2018.
While analysts expect a further decline of 15% in earnings per share for 2019, as the business continues to invest in growth, costs are coming down and sales are going up. McColl’s interim numbers for the 26-week period ending 26 May show a 1% increase in like-for-like sales and a decline in adjusted administrative expenses as a percentage of revenue of 0.3% to 25.2%. Adjusted EBITDA and profit before tax came in at £13m and £0.2m, respectively.
As part of its plan to rekindle growth, McColl’s management is working closely with Morrisons to offer customers a broader range of products at a lower price. The group is also trialling a “Morrisons Daily” format at 10 stores.
A more significant range and lower prices aren’t management’s only growth initiatives. The business is also rapidly reshaping its store estate. Some 41 underperforming stores and newsagents and smaller convenience stores were divested during the first half of this year while three new convenience stores were opened.
All of these efforts should, the City believes, help the company return to growth in 2020. With this being the case, I think the stock is a steal today trading at just nine times forward earnings. This makes McColls the cheapest the stock in the UK food and drug retailing industry. On top of this appealing valuation, McColl’s supports a dividend yield of 5.8%, so you’ll be paid to wait for earnings to recover.
So overall, if you’re looking for an undervalued retailer to add to your portfolio, I highly recommend taking a closer look at McColl’s. As the company’s growth initiatives begin to yield results over the next few years, the shares could rise substantially from current levels.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended McColl's Retail and 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.