J Sainsbury (LSE: SBRY) is the UK’s second-largest supermarket, but it still has to compete hard with budget chains Aldi and Lidl. Sainsbury’s share price has dropped nearly 30% over the last year, as investors have priced in the risk of falling profits.
However, today’s half-year results look fairly solid to me. With a 6% dividend yield on offer, I think Sainsbury’s is worth a closer look as a potential buy.
Dividend up in tough market
We’ve all felt the impact of rising prices on our weekly shop. But Sainsbury’s says that it hasn’t been passing on the full impact of higher costs to customers. Instead, the company has chosen to absorb some costs in order to make sure its prices stay competitive.
As a result, Sainsbury’s half-year profit fell by 8% to £340m, despite a 4.4% increase in sales (excluding fuel).
It’s certainly a tough market for food retailers at the moment, but I don’t see any reason to be worried by today’s numbers.
CEO Simon Roberts also seems confident. He’s increased Sainsbury’s interim dividend by 22% to 3.9p per share. By my calculations, this suggests the full-year payout could be around 12.6p, giving a dividend yield of 6.2%.
There’s just one problem
Sainsbury’s is a big brand. I’m confident this business should have a solid future.
As an income investor, the 6% dividend yield is also tempting for me.
Despite these attractions, I don’t own Sainsbury’s shares. The reason for this is that this FTSE 100 stock has not really delivered for shareholders over the long term. This table shows how Sainsbury’s share price has changed over the last 20 years:
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Although shareholders have received some useful dividends, I’d guess that most long-term investors have seen the value of their shares fall. Why?
Not very profitable
Supermarkets require lots of large buildings and big fleets of vehicles. This means that there’s a lot of money tied up in these businesses.
In investing jargon, that’s known as capital employed. I estimate the capital employed in Sainsbury’s supermarket business at around £15bn. These assets require spending of around £700m per year to keep them updated and in good condition.
The problem is that supermarket profit margins are pretty low. Sainsbury’s operating margin is around 3%. This means that the group’s return on capital employed is also low — around 6%, I estimate.
Once the company has paid its tax and interest bills, subtracted money for a dividend and set aside money for next year’s capital spending, there’s almost nothing left. It’s like running to stand still. In my view, this is why Sainsbury’s shares have performed badly for so long.
Will it be different this time?
To be fair, I think that chief executive Simon Roberts is doing a good job. Sainsbury’s profitability has improved since 2019. Debt levels have fallen, and I think the dividend looks quite safe.
It’s possible that Mr Roberts will find a way to create more value for shareholders. That could lead to attractive returns, based on the current share price.
Personally, this isn’t a risk I’m willing to take. I won’t be buying Sainsbury’s shares in November.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Sainsbury (J). 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.