Should investors be shopping for income at Sainsbury?

21st May 2014

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Mindful Money contributor Edmund Shing, of BCS Asset Management, says that despite the tail of woe in the supermarket sector, one high street name may hold appeal for income investors.

UK Food Retailers have been battered of late – the main culprits being:

  1. The lack of UK households’ purchasing power, with inflation consistently running ahead of wage growth;
  2. The rise and rise of German food discount chains Aldi and Lidl

This has led to savage drops in share prices in the sector as investors have worried over the resultant combination of increasing price pressures and losses of market share: Tesco (LDN:TSCO) has fallen from 378p in September last year to just 302p currently; William Morrison (LON:WRM) has slid from 303p back then to just 204p now; and Sainsbury (LON:SBRY) has tumbled to 337p today from 410p in November 2013.

Why Sainsbury? Hasn’t sales growth been falling?

Analysts will point to slowing like-for-like sales growth (comparing only the sales at stores that have been open at least 1 year) at Sainsbury as a real cause for concern; in the year to March 2014, it is true that Sainsbury only managed yearly like-for-like sales growth of 0.2%, the lowest for 9 years. Overall sales growth slowed to 2.7% in this latest year, again the slowest growth rate recorded since 2004 (Figure 1).

1. Sainsbury See Slowing Growth But Higher Profit Margins

Source: Company annual reports

But note also from Figure 1 that Sainsbury’s overall profitability, as measured by operating profit margins, has continued to rise to 4.2%, a level of profitability not seen since the year 2000! So despite the pressures from the discounters, Sainsbury is managing to squeeze out better profitability year by year, unlike the falling profit margins at Tesco, Morrisons and even Wal-Mart (US owner of Asda).

And retail sales could be getting better…

Moreover, April retail sales in the UK (excluding petrol and diesel sales) posted a surprising jump today of 1.8% over the month of March, and a sizable 7.7% yearly growth rate when compared with April last year. In fact, retail sales over the last three months are now rising at their fastest rate for a decade! So there may be some relief for supermarkets to come. Indeed, excluding April 2011 (the Royal Wedding), food sales in April rose at the fastest pace since records began in 1988…

There’s value to be had

Sainsbury stands up well on a raft of value metrics too: at the current 337p share price, it trades on 11x prospective P/E and a price/book value ratio of 1.0x. So yes there may not be a huge amount of growth to be had at present, but I would suggest that this fact is already more than adequately reflected in these lowly valuation multiples. And yet, Sainsbury’s underlying book value per share (an accounting measure of company value) continues to grow steadily (Figure 2) to stand today at 320p, while the net profitability earned on this equity continues to rise, hitting over 12% as of March 2014.

2. Steady Growth in Book Value, While ROE remains at Decade High

Source: Company annual reports

 

 The Punchline: a well-supported, growing 5% dividend yield…

Finally, for income investors who are tired of the ever-shrinking yields available from risk-less cash deposit accounts and from low-risk government and corporate bonds, there is the key attraction of a 5% dividend yield on offer. This is well supported as Sainsbury is forecast to continue to grow earnings modestly going forwards, with a payout ratio (dividends as a proportion of earnings per share) that is still comfortable at 55%. Note how dividends per share have grown steadily since 2005, at a compound annual growth rate of over 9% (Figure 3), suggesting that we can count on modest single-digit dividend growth ahead as well.

3. Nine Years of Uninterrupted Dividend Growth
Source: Company annual reports

 

And finally, share price breaks out of downtrend

After a precipitous 26% drop from November 2013 peak to March 2014 trough, Sainsbury looks like it it starting to regain some of those losses, breaking out from the prior downtrend and establishing a new uptrend (Figure 4).

4. Sainsbury Moving Higher

Source: Bloomberg

Overall then, I think there are good reasons to expect some further progress from Sainsbury from both a macro and micro point of view, while profitability remains relatively high and while you are compensated for your patience with a 5% dividend yield. Perhaps not the sexiest investment proposition, but I think one that offers an attractive risk-reward trade-off.

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