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How low can the Sainsbury share price go?

The J Sainsbury (LSE: SBRY) share price has lagged the FTSE 100 during the recent sell-off and has fallen by nearly 50% over the last year.

Good news has been in short supply. In March, the company’s ambitious plan to merge with Asda was blocked by the industry regulator. In May, annual results showed pre-tax profit down by 29% to £219m. If that wasn’t enough, Sainsbury’s most recent trading update showed like-for-like sales falling across the business.

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What next?

Chief executive Mike Coupe has cut prices on more than 1,000 products to try and boost sales. But this won’t help the firm’s profit margins, which are already lower than those of its two main listed rivals.

Will Sainsbury’s end up going bust? My colleague Karl Loomes thinks this is unlikely, and I agree. But that doesn’t necessarily mean the shares don’t have further to fall. I’ve been taking a fresh look at this troubled supermarket’s accounts. Here, I’ll explain what I think is likely to happen next.

Hidden value?

Is there hidden value in Sainsbury’s large store estate? At the time of writing, the group’s market-cap was £3.9bn and its share price 181p. By contrast, the supermarket’s latest accounts value its property portfolio at £10.4bn and indicate a tangible book value of 335p per share.

I like asset-backed investments. But experience has taught me in situations like this, a company’s price/book ratio is often dictated by the earning power of its assets, not their value.

Sainsbury’s weak profit margins and low growth suggest to me a cautious valuation is appropriate. The group’s huge store estate may be a valuable asset on paper, but these big supermarkets aren’t very profitable at the moment. They could also be hard to sell.

Debt worries?

Sainsbury’s net debt was £1,636m at the start of March. Coupe has committed to reduce this figure by £600m over the next three years. Net debt fell by £222m last year, so this plan looks realistic enough. But it also suggests the CEO feels the group’s current borrowing levels are uncomfortably high.

I don’t see any immediate risks here, but I would say that Sainsbury’s gearing is currently higher than Tesco’s, even though Tesco is more profitable. I don’t think that’s ideal.

Will the SBRY share price keep falling?

Sainsbury’s stock currently trades on a forecast price/earnings ratio of 8.8, with a 6.1% dividend yield. That sounds cheap. But it’s worth remembering the firm’s underlying earnings per share have fallen by 32% since 2013/14. The dividend has been cut by 36% over the same period. I think the current share price is a fair reflection of the group’s declining profits.

Although shareholders were rewarded with a 7% dividend hike last year, I’m not convinced this rate of growth is sustainable. Nor are City analysts. They’re forecasting a flat payout for this year and expect earnings per share to fall by 8%.

In my opinion, Sainsbury’s has a tough few years ahead. Although the shares could offer value at this level, any fresh disappointments could see the stock hit fresh lows. I plan to stay on the sidelines, for now.

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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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