Sainsbury’s yield hits a tasty 5.4%. Why I still say Tesco is a better buy

Defensive picks to shore up your portfolio only make sense if 5%+ dividends will last long term. Do the UK supermarket giants offer the best option?

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The UK’s second largest supermarket J Sainsbury (LSE:SBRY) posted some pretty rubbish numbers in its interim half-year results.

However, bosses pumped up dividends by 3% to 6.6p. So is there any value in buying the cheaper Sainsbury’s share price with the yield now at 5.4%?

After all, CFO Kevin O’Byrne highlighted “strong retail cash flow generation of £698m“, and Sainsbury’s shares are trading at only 9 times trailing earnings.

I would be careful. Half-year profits plummeted to just £9m compared to £107m for the same period last year.

The idea that a fearful public would stockpile food to beat Brexit shortages has clearly not panned out. Sainsbury’s overall sales across the first half of 2019 were down 0.2%, with retail dipping 0.6% and like-for-like sales under water by 1%.

Underlying profit fell by £41m to £238m and underlying earnings per share dropped by 16%.

In the margins

I’ve talked about FTSE 100 companies with cast-iron 5% to 7% yields before. Yearly payouts you can rely on? Manna from heaven for the smart income investor. But I’m not confident Sainsbury’s can afford to keep up this pace.

Interrogating the balance sheet turns up a lot of bracketed numbers. That means losses across the board, which will stack up in time.

The margins in this business are very, very tight. Revenues of £16.9bn are only bringing in £238m in profits. CEO Mike Coupe’s outlook for the sector says it all to me: “Retail markets remain highly competitive and the consumer outlook remains uncertain.”

Tesco to the rescue?

If you’re looking at the supermarkets and thinking you need consumer staples for a defensive portfolio pick, I’d say Tesco (LSE:TSCO) is your best play. It’s not as exciting as the likes of a high-profit, fast-growth AIM firm, but of your FTSE 100 options, you won’t find a better pick, I feel.

The surprise exit of Dave Lewis as CEO in early October came as a shock, as Lewis shepherded Tesco through some tough times. When he arrived in 2014, the supermarket’s sales were dropping nearly 5% a year. Lewis steadied the ship to scrape back profits so he will be missed.

Tesco’s interim results for 2019/2020 shone a light on growing dividends. The interim dividend of 2.65p is 59% higher than last year’s effort, and City analysts expect an 11.5% hike in earnings per share over the next three years.

So while I think Tesco is a better option, would I buy it? No. The biggest issue is that neither market leader Tesco nor its close second Sainsbury’s really offer what the long-term investor needs from a defensive portfolio pick. Both are losing market share to Aldi and Lidl.

These privately-owned European upstarts are swiping customers at a rapid clip and now control 14% market share, a 0.8% growth rate that data analyst Kantar Worldwide estimates is worth nearly a billion pounds a year.

Grow faster

Innovation and new market share equals growth, which in turn equals share price valuations going up. But I’m not seeing that dynamism from Sainsbury’s and Tesco.

Kantar suggests that Sainsbury’s has returned to growth in the weeks since the end of September, but even when you count the savings from running stores with air hangar-sized economies of scale, and Sainsbury’s spending £203m across the half to review its estate and close down shops, it’s not enough. 

I would have my eyes on bigger prizes outside this sector if I was really serious about defensive long-term gains.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Tom has no position in the shares mentioned. The Motley Fool UK has recommended Tesco. 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.

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