It must be five years since I wrote that I was sweeping the big supermarkets out of my portfolio. I can’t say I regret that decision.
I certainly don’t when I look at the J Sainsbury (LSE: SBRY) share price, which is trading almost 20% lower than it was back then. The last year has been particularly brutal, with the stock down a third, as investors fled following the failed £7.3bn takeover of Asda. They’re creeping back this morning, although I wouldn’t crack open the bubbly just yet.
The FTSE 100 group’s stock is trading almost 2% higher after reporting “increased grocery momentum as we create one multi-brand, multi-channel business.” That shows how low investor expectations have fallen, given today’s numbers included a hefty 15% drop in underlying profit before tax to £238m for the 28 weeks to 21 September.
Management blamed the £41m reduction on “the combined impact of the phasing of cost savings, higher marketing costs and tough weather comparatives,” and said it was in line with guidance. Like-for-like sales (excluding fuel) fell 1%, while group sales were down 0.2% to £16.86bn.
Sainsbury’s also reviewed its store estate, which led to £203m of one-off costs across the half, and was the main reason statutory profit before tax fell from £107m to just £9m.
CEO Mike Coupe hailed lowered prices on everyday food and groceries, a new range of value brands, significantly improved customer satisfaction and continued investment in hundreds of Sainsbury’s and Argos stores. He also cautioned that “retail markets remain highly competitive and the consumer outlook remains uncertain,” but said second-half profits should benefit from the annualisation of last year’s colleague wage increase, a normalisation of marketing costs, and weather comparatives.
It isn’t disastrous, but it does continue the theme of slow decline as the German discounters Aldi and Lidl expand and consumers retrench. Some investors would buy and hold Sainsbury’s forever for the yield, which is currently 5.1%, covered 1.9 times by earnings.
A forecast valuation of 10.3 times earnings may also tempt. However, earnings are forecast to fall this year and next, and operating margins are wafer-thin at 1.1%, although expected to climb to 2%.
This is a tough sector. Just look at FTSE 100 rival Morrisons (LSE: MRW), which is down 20% this year, although it’s up 27% measured over five years. Management is gamely testing out new ways to grow the business, targeting £1bn of wholesale revenues, expanding online via Amazon, and extending its convenience store network.
This is having a positive effect, with City analysts forecasting a 29% jump in earnings per share this year, and 7% next (compared to drops of 8% and 3% at Sainsbury’s). The Morrisons share price is more expensive as a result, trading at 14.7 times forecast earnings, albeit with a lower dividend of 3.5%, also covered 1.9 times. Again, operating margins of 2.3% are wafer-thin.
I feel a well-balanced portfolio ought to have some space for the big supermarkets, but I’m wary of recommending companies with such vast, sprawling operations that end up working to such fine margins. You might find other more convincing income plays out there.
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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.