Sainsburys has a 5% dividend yield, from a company which has raised its dividend by 9% a year over the last decade, and operates in a very defensive sector.
Growth and quality, what’s not to like?
Here’s a quick run-down of some of the key stats that I track:
- 10-year revenue growth rate = 5%
- 10-year earnings per share growth rate = 14%
- 10-year dividend per share growth rate = 9%
- 10-year overall growth rate = 9.6%
- 10-year growth quality (how often revenues, earnings or dividends went up) = 88%
Those numbers compare very favourably with the FTSE 100, which had a growth rate of 2.3% over the last decade and a growth quality score of 58%. You can see what Sainsbury’s results look like in the chart below:
Of course, good past results don’t guarantee good future results, but I do think they’re indicative, and I’d rather invest in a company that has a long track record of profitable dividend growth than one that doesn’t.
For me, the question of what’s not to like rests with the company’s financial obligations.
Sainsbury has kept its borrowings at what I would call a slightly high level, with almost £2.8 billion of interest-bearing debts. This is quite high relative to its average post-tax profits in the last decade of around £400 million (borrowings are 7 times that amount). It’s also high relative to my ballpark estimate of what the company may earn in the next decade, where that estimate is just under £700 million a year (and borrowings are still over 4 times that amount).
Generally, I prefer borrowings to be less than 5 times my estimate of future earnings, which they are in this case, but it’s getting close.
On top of that is the company’s pension scheme, which has liabilities of about £6.5 billion, almost 10 times my estimate of average earnings over the next decade (£700 million).
I think that once a pension scheme gets to around 10 times future earnings, it starts to be a significant drag on the company’s cash, and more importantly it’s cash going into the pension that won’t be going to shareholders.
The pension deficit is also quite large at almost £700 million. That’s one entire year’s earnings required to fully fund the scheme. That’s certainly something to think about.
However, I don’t think it would put me off and so, given the defensiveness of the industry in which Sainsbury operates, as well as its financial results over the last decade, I’d be happy to invest at the right price.
Good companies with high yields are not always easy to find
One obvious indication of an attractive price is a high dividend yield. It’s not the only thing you should look at, but if the dividend can grow over time then a high yield is a reasonable place to start.
As I said at the beginning, Sainsbury currently yields more than 5%. That’s almost 50% better, relatively speaking, than the 3.5% yield on offer from the FTSE 100, so Sainsbury is definitely a high-yield share.
In fact, out of the 240 consistently dividend-paying companies that I track (where the average yield is currently a measly 3.1%, because these are an above-average group of companies in terms of quality and growth, and therefore typically command a premium price), Sainsbury has a top decile yield.
The shares are quite cheap relative to earnings too. While the FTSE 100 at 6,870 is priced at 14.5 times its average earnings over the last decade (a PE10 of 14.5 in other words), Sainsbury has a PE10 ratio of just 14.1.
That may not sound like a bargain, but given Sainsbury’s superior record of profitable dividend growth, it’s almost shockingly cheap.
It’s a good company at a low price, but what about Aldi and Lidl?
So why are Sainsbury shares so cheap if the company is so good? The answer, and it applies to the other major supermarkets as well, is Aldi and Lidl.
I won’t go into the details, but (apparently) Aldi and Lidl are set to overthrow Sainsbury, Tesco, Asda and Morrisons and take over the UK supermarket scene. The big players cannot compete, and they’re already dead; they just don’t know it yet.
Personally, I think the threat from Aldi and Lidl is about as overblown a story as it’s possible to get, but that’s not the most important thing. What’s more important is that I don’t think the decline of Sainsbury is the most likely outcome; not in the next decade at any rate.
More likely, I think, is that it will continue to make profits and pay dividends, and may even continue to grow both over time. Eventually, at some point, investors will get bored with the Aldi and Lidl story, and supermarkets may even have a bit of good luck and come back into fashion (or as much as supermarkets can be fashionable anyway).
If that happens, valuations and share prices will climb as investors realise that a 5% yield from a solid, profitable, growing company is a steal.
At any rate, I don’t think there are too many shares out there that can match Sainsbury shares in terms of low risk, high quality and high yield (which is highlighted by the fact that it ranks at number 7 out of 240 on my defensive value stock screen).
Disclosure: I don’t own any Sainsbury shares because I already own Tesco and Morrisons, and don’t want to over-concentrate my investments in any one sector.
Hi John
If you didn’t hold Tesco and Morrisons, which 2 of Tesco, Morrisons and Sainsburys would be your choice currently?
The hit in Morrisons share price may make it the most attractive, but it also has the biggest hill to climb to get competitive in the with the low cost suppliers and in the online space.
Thanks
Tom
Hi Tom
I’d Probably prefer to hold Tesco and Sainsbury. I think there is more risk around Morissons, which is obviously showing up in the price and yield, but I’m not going to swap out of Morissons in favour of Sainsbury because as soon as I do the Morissons share price will probably go up by 30%!
Agreed – the sector is out of favour currently but these are the two from the sector I would, and do, hold. A couple of years back I flirted with Morrison for a brief spell but it soon became clear they were not in the same league as the others on a number of fronts.
Morissons is the plucky underdog, but you’ve got to give it to them – they’re certainly going all guns blazing with their current advertising campaign.
Oh, I love this subject. I love it.
Shopping for groceries is changing rapidly. You only need to look at Amazon on the West Coast of US. Amazon took the game with the groceries supermarkets at a new level. I bet that next they will come to the UK, especially as the Amazon UK boss is very close to the CEO.
Amazon is selling recipes and not groceries. In US you can choose what to cook, and get the exact ingredients. I bet there is a nice margin on that, but as long as I can get Jamie Oliver emailed on the iPad showing me what to do, I can put up a show.
These days you don’t need to go to the supermarket, although I still go there from time to time, but spend only £10 or so. There is no pleasure in pushing the trolley these days. Supermarkets fell out of favour with they most important clients: the middle class and upper class. It won’t take long and to be seen in a supermarket will look bad on you.
There is a change in behaviour and also a change in demographic. Older people like to go in deli shops now and buy nice and marked-up stuff, busy people like to wait at home for a delivery. There are only the low wages, the unemployed, and the people on benefits left for Tesco, Morrison and even Sainsburys to take the fight with Asda, Lidl and the others.
Saying that Sainsburys is the better of the three. And they still have Jamie Oliver!!
Hi John,
Slightly confused. Is dividend growth rate 9% per year over last decade so north of 90% or in total 9%?
Same for earnings per share figure growth of 14% you quote above?
Hi Raj
Yes the growth rate is 9% and 14% PER YEAR respectively, but there are a few details I should point out. I don’t just take the annualised growth rate between the dividend (for example) 10 years ago and the dividend today. That would make the growth rate too dependent on those two individual years. Instead I use an old Ben Graham trick and average out the dividend from years 10,9 and 8, and calculate the growth rate to the average dividend in the most recent 3 years. That way any single exceptionally high or low dividends (or earnings, or revenue) are smoothed out, at least to some extent.
You can see how this works in my worksheet/spreadsheet here: https://www.ukvalueinvestor.com/free-resources/
Hi John
I am a Sainsburys holder. I broadly agree with you. Rumours of the demise of the big Supermarkets is a little premature. The markets may well change their minds and we can assess whether there is a problem or opportunity for us.
Regards
Ken
Hi Ken, I just don’t see how Aldi can kill Tesco/Sainsbury. If Sainsbury wanted it could spin off an Aldi competitor under a new brand and run it on a zero-profit basis to stop the discounters climbing up the value chain. Of course I could be wrong, but if I’m not then there’s a good chance for a re-rating at some point, and solid dividends in the meantime.
Hi John,
One of the things that bothers me about the supermarkets is the lack of free cash flow after annual capex. This seems to be the case almost every year. They seem to be investing to stand still.
Hi Jim, you’re right, free cash flow has been a little short for quite a while. I do look at the ratio of free cash flow to dividends, but so far haven’t found it to be a reliable predictor of future dividend growth (or cuts, more importantly). So for now I’ll keep investing even if free cash is a little short, until something happens where I can learn a bit more about how it correlates with future returns.
What I don’t want to do is rule out companies with weak free cash flow and pay an opportunity cost from not investing (i.e. missing out on good returns where the weak free cash flow wasn’t really an issue).
It’s an interesting one. I feel it is somewhat similar to AstraZeneca a couple of years ago. On the horizon are some big threats that may cause major damage to profits. Not just ALDI/LIDL, but other player in the online market. I think Eugen may be a little over-keen, but I definitely think that in 10-20 years time, grocery shopping will look very different from today.
I don’t think online is really rushing in and changing the game in the UK, it still feels like saving time pushing the trolley and effort carrying the groceries is the primary reason given for people to want to shop online. Give it time for much better integration of cooking shows, tv, cooking websites and supermarkets and it will start looking very different. We’ll shop online because otherwise we have to write down every little thing Jamie said on a piece of paper (or our phone) and then wander aimlessly up and down the aisles looking for fennel seeds.
Any supermarket can start selling its stuff online and get the “time saving” if there even is one. But I’m not sure every supermarket is going to be so plugged in to see the new mode coming and back the right model. There’ll definitely be an opportunity for a new player, maybe Amazon, to invent a new space. The existing supermarkets may well be left rearranging the deck chairs as their model sinks, while someone new runs away with the market.
If we get to a point where it’s far easier to shop on your phone than in the store, I think supermarkets need to find new ways to differentiate themselves to their customers. I don’t feel any better booking my hotel through expedia vs booking.com. Will I feel better clicking the Waitrose or Sainsburys order button for a chicken pie recipe? Will I have any loyalty to my regular Tesco when a new player comes on the market, if I’m just shopping from my lounge?
I think in one form or another, these changes are coming. But I think it will take quite some time for it to be the dominant way of food shopping. 5 years soonest, 10 years more likely.
Hi Bob, some very insightful comments there. What you’ve said is similar to how I think about the high street. Personally, I’ve never liked shopping so I do most of it online. Shopping as a requirement for survival (I need a pencil therefore I go to Staples.com or similar) will go online, so visiting the high street or supermarket has to do the things that online simply cannot do.
What it can’t do is Real World Experience, so like the giant shopping malls, shopping as a leisure experience becomes more important. Tesco wants to put gyms and creches and Starbucks and who knows what else into giant stores that may be like mini-malls. If I can drop my son off in a Tesco Creche (or in their extra-school-work-centre as they have in a store near me) for a couple of hours, do a bit of shopping, have some tea and a sandwich, shop a bit more and play some video games, or have a massage, then I might actually go to the supermarket, and none of that I can do online.
And you can’t touch the food online! When the stuff comes in the back of a van there are ‘substitute’ items and sometimes the apples are too big or small or whatever.
And at some point Jamie Oliver will die and the middle class will be free from having to cook whatever they see him cook. Personally I’m not even sure I’ve even seen a whole Jamie Oliver program let alone cook something he’s cooked (unless he likes cheese sandwiches or beans on toast).
There is and will be change in retail, but we’re very likely to always have a high street and supermarkets.
It’s like the arguments about robots and computers replacing humans in the world of work. There will be changes, perhaps massive ones that require a total rethink of the point of the capitalist system. The obvious thought experiment is to say, what would the world look like if computers and robots could do EVERYTHING better than people? What would people do for a living then?
It’s an interesting enough question, but it’s slightly wrong in that robots cannot do everything that humans do, because robots cannot be human. Therefore, if I want a ‘handmade’ table, it has to have been made by a human; it is an unautomatable job.
In the same way, if I want to squeeze a banana before buying it, I cannot do that online, unless we live in some sort of virtual reality system which mimics reality perfection, like the Matrix, and personally I think the virtual reality system we already call ‘reality’ works pretty well most of the time already.
Bob
I was not saying it will happen the next day. However it is good to remember the stock markets correct well before the events.
The difference between me and John is that he looks to the past figures trying to project them in the future. Myself I am more conscious that the price I pay today for a share in the business is the discounted value of the future free cash-flow the firm will produce over the next 10 years.
I do get concern when I see firms with negative cash flow, as two of the three examples above. The result of negative free cash flow combined with paying high dividends is an erosion of the capital base. For example the net assets for Tesco have shrank to £14.72 bln from £16.66 bln in the conditions that the debt shrank by £700m. This is a company for which the balance sheet is smaller by £2bln in only one year or 14%. The shares are 20% down over the year. The company made £970m after tax profit (an improvement from nothing in 12-13) but paid almost double in dividends.
I don’t want to project this into the future. I just hope that there won’t be more loses this year from discontinued operations, although the Turkey business is for sale and I don’t expect locals to pay the full price for it.
Even Warren Buffett seems to leave Tesco’s boat, as he sold a third of his shares. Is that full capitulation on this stock, I am not sure, myself I still wait for a dividend rebase before investing.
I realised this post should be about Sainsbury’s but I was not able to stop speaking about Tesco’s figures.
I did manage to look at Sainsbury’s figures and those are not very good either. The main concern here is the lower profit margin than Tesco’s on sales. It is like you employed Jamie Oliver (bless him), use better packaging and sell better products (at least this is the perception) and you don’t charge adequately for this.
I do my shopping online at Ocado and Sainsbury’s and my neighbours use only mainly the online service from Sainsbury’s. Today after the raining stopped I did a short market research and all of my neighbours I was able to find believed they pay more than for Tesco’s similar products although they did not check this. Something is wrong with the Sainsbury’s managers if they are not able to make a margin.
I may have done something stupid yesterday. I added on my buying list Dairie Crest and bought a few shares, although the trend is negative. I look at it as a turnaround situation, cheap company, but the main driver is my believe that the milk price will get lower from next year as the EU milk quotas will disappear from 2015. Irish farmers looks they are well prepared for this, I am not sure how the English and French farmers are, but here we go. There are obviously exchange rates involved, but hopefully the diary management could be smart enough to hedge those to start with.
There could be that supermarkets will benefit from this, or they could be stupid enough to start a milk price battle. I just don’t know, so I leave this with you.
Good insight from Kantar Research on supermarkets. It seems that Tesco lost 1 million customers a week.
We also had the first quarter figures in from Tesco, which were as bad as expected. It is really clear now that the free cash flow is smaller than the dividend payment, so a dividend re-basement should in sight. I may buy a few shares then!
John, I don’t see the optimism you show and I think the numbers are a little questionable.
It doesn’t matter how much a company like Sainsbury grows it’s revenue if it can’t increase it’s profits. Yes it’s grown it’s EPS but this is no measure of the success of a company as not all earnings are equal. In addition a growing dividend is not a measure of success either in that it either represents a falling share price (as is the case here) or a danger if cash flows don’t meet the needs to the dividend and the company has to borrow to keep growing the dividend (as is also the case here).
Looking at the Revenue and Profit respectively in 2008 and to March 2014 — Sainsbury has grown revenue by 21.6% but it’s profit is projected to remain the same at £735M. This is a company that is running to stand still and it’s operating on a 3% margin – the thinnest in the quoted supermarket sector.
Sainsbury is now starting to lose market share and it will lose it fast, as the sector is NOT defensive as you remarked. 10 Years ago yes I would have agreed with you when the average town had 1-3 supermarkets. Now they have 5-6 plus Aldi-Lidl-Poundland-Poundstretcher- The Range – Coop – Budgens – and many more.
Sainsbury is set to have a fall in profits into 2016 and there is no sign of growth or profit retention in this company. Just about the only reason to buy Sainsbury is the hope that Qatari Holdings increase t heir stake or do a Harrods and take the company completely under their wing.
Otherwise it’s a basket case.
John — Here is a further extract from the article in the Telegraph today. This highlights the potential predicament Sainsbury might find itself. It’s not inconceivable that Sainsbury could be making a loss in 2-3 years if the latter strategy of smashing competitor margins turns out to be true :-
“””If Lewis decides to rebase Tesco’s margins then Sainsbury’s and Morrisons, which have margins of less than 4pc, could be severely squeezed. Morrisons has already warned that its profits will fall by half this year as it lowers prices to compete with Aldi and Lidl. The change of leadership at Tesco has given Dalton Philips, chief executive of Morrisons, a new concern. It will also strengthen the resolve of frustrated shareholders to push for change at the Bradford-based company.
When Lewis starts work at Tesco’s Cheshunt headquarters on Oct 1, a lot will be a stake, but not just for Britain’s biggest retailer. The rebuilding of Tesco will not be victimless, and Lewis has shown how far he is willing to go to protect his company’s brand. “””
Hi LR, I guess I’m less pessimistic than you on supermarkets in general. I think the best policy is to wait 5 years or so and then we might have an idea of how things panned out and whether their current problems are cyclical or secular.