What do you call a share that has a 5% dividend yield, from a company which has raised its dividend by 9% a year over the last decade, and where that company is in about as defensive a sector as you’re likely to find?
To me that sounds a lot like Sainsbury shares.
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 growth quality 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 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 in, 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 a 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.