A Warning for Sainsbury's Future Dividends

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LONDON -- The shock profit warning from FTSE 100 (INDEX: ^FTSE) supermarket titan Tesco (OTC: TSCDY) in January continues to preoccupy many investors.

Has Berkshire Hathaway (NYS: BRK.A) (NYS: BRK.B) CEO Warren Buffett got it right in buying more shares in the world's third-largest retailer? Or has U.K. master investor Neil Woodford made the correct call in selling his entire holding in the company?

Let's give Tesco a rest, at least for a minute, and turn the spotlight on one of its U.K. rivals, J Sainsbury (OTC: JSAIY), which announced its full-year results this morning.


Understanding customers
Sainsbury reported total sales up 6.8% to 24.5 billion pounds for the year ended March 17, with like-for-like sales growth of 4.5% and new space -- 19 supermarkets, 28 extensions, and 73 convenience stores -- contributing 2.3%.

Profit before tax came in at 799 million pounds, 3.4% down on 2010-2011, as a profit of 83 million pounds on the sale and leaseback of mature stores was lower than last year. Underlying profit before tax was up 7.1% to 712 million pounds, and underlying basic earnings per share grew 6% to 28.1 pence.

The results were modestly ahead of analysts' consensus expectations, and a 6.6% hike in the dividend to 16.1 pence was above the forecast 15.7 pence. However, there was a sting in the tail with the dividend -- more on that later.

Sainsbury's own-label ranges and its convenience store, online, and nonfood offers are all growing ahead of the wider market, and the group's market share has increased to 16.6% -- the highest it has been in almost a decade.

Chief executive Justin King said, "We are succeeding by understanding what our customers want," adding that Sainsbury's "Brand Match" promotion has engendered a high level of trust on pricing among shoppers. That may be seen as a pointed reference to Tesco's difficulties, which include losing touch with customers' needs and trust on pricing.

In 2012-2013, Sainsbury plans to reduce core capital expenditure from last year's 1.2 billion pounds to a still-substantial 1 billion pounds as it opens new stores in areas where it's under-represented, steps up the refurbishment of existing stores, and invests to support future online growth.

While the wider economic situation remains uncertain, Sainsbury's chief exec is "confident that our clear strategy, market insight and strong values will enable us to make further progress both in our core food and non-food businesses, as well as new channels and services in the year ahead."

Valuation
After Tesco's bombshell and Wm. Morrison recently reporting its first decline in like-for-like sales since 2005, Sainsbury has become the most highly rated U.K. supermarket. Ahead of this morning's results, forecasts for 2012-2013 were as follows:

 Company

Share Price

Forecast P/E

Forecast EPS Growth

Forecast Dividend Yield

Tesco

323 pence

9.3 times

4.7%

4.7%

Sainsbury

301 pence

10.3 times

7.5%

5.6%

Morrison

275 pence

9.7 times

8.8%

4.4%

Source: Morningstar.

Sainsbury's shares are up nearly 3% at the time of writing, putting it on the FTSE 100 top risers board. The P/E is the highest in the sector, but it does have that high dividend yield that has been attracting income seekers.

However, as I mentioned earlier, there was a bit of a sting in the tail with Sainsbury's latest dividend announcement.

The final dividend of 11.6 pence (to be paid on July 13, with an ex-dividend date of May 16) gives 16. pence for the full year. The dividend is covered 1.75 times by earnings, which is in line with the company's existing policy of maintaining cover in the range of 1.5 to 1.75 times.

Sainsbury has now amended the dividend policy: "The Board plans to increase the dividend each year and now intends to build cover to two times over the medium term."

What does this mean for shareholders? Well, simply that future dividend growth will lag behind earnings growth until such time as EPS is double the dividend.

In contrast, Tesco's policy continues to be to grow its dividend at the same rate as earnings, while Morrison is actually going the opposite way of Sainsbury, lowering its dividend cover and thereby increasing the dividend ahead of earnings growth.

Sainsbury's higher yield may still be attractive for immediate income, but medium-term dividend growth relative to its peers is less appealing under the new policy than it was under the old.

Supermarket sweep
As the supermarkets' P/Es and yields suggest, this sector isn't exactly the flavor of the month (or, indeed, of the past year), which means this may be a good time to invest.

Which is the best value of the three?

  • Medium-yielding Tesco on the lowest P/E, but with minimal earnings growth for at least the immediate future
  • Higher-yielding Sainsbury, with the highest P/E and dividend increases lagging forecast single-digit earnings growth
  • Lower-yielding Morrison on a medium P/E, but with higher forecast dividend and earnings growth

Supermarkets aren't on my own shopping list, and it looks a tough choice between them. If you think the sector is undervalued, perhaps spreading your bets across the companies would be the way to go.

He avoided techs in the dot-com bubble and banks in the credit boom. But just where is dividend expert Neil Woodford investing today? All is revealed in this free Motley Fool report -- "8 Shares Held By Britain's Super Investor."

Further investment opportunities:

At the time this article was published G A Chester does not own shares in any of the companies mentioned in this article.Motley Fool newsletter serviceshave recommended buying shares of Tesco. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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