City analysts following supermarket chain J Sainsbury (LSE: SBRY) expect the dividend to decline by just over 7% next year.
And if that happens, it will be a blow for shareholders who are in the stock for income.
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But why is it likely to happen? After all, those same analysts have pencilled in modest growth in revenue for the current trading year and for the following period to March 2024.
Earnings on the slide
However, the reason for the decline looks like it’s because the level of the dividend is tied to earnings. In last year’s full-year report, the directors said the dividend payout ratio was running at around 53% of underlying earnings. And they had an ambition to raise it to 60%.
But earnings are on the slide, by just over 3% this trading year and by almost 8% the next. So the analysts look like they are tracking those declining profits lower with their dividend predictions.
This is not good news. When entering into dividend-led investments, I look for rising financial figures. And that means identifying a stream of rising dividends backed by a business capable of delivering annual upticks in revenue, earnings and cash flow.
For me then, J Sainsbury now fails that fundamental test. Profit margins are caught in a pincer squeeze between rising costs and pressure to keep selling prices down.
For example, staff wages have been rising. And cash-strapped customers can choose to shop elsewhere if Sainsbury’s prices become too high for them.
The company is facing the problem of competition head on. And it price-matched rival supermarket Aldi on around 300 products. But such initiatives tend to bear down on profits. And that means lower dividends for shareholders given the current dividend policy.
This is not the dividend progression I’m looking for, it’s dividend regression.
The yield remains high
But there are positives in the business. On Tuesday, the company announced a deal to buy the freeholds of 21 of its supermarkets for just under £431m.
The stores are currently leased from investment vehicle Highbury and Dragon and are among 26 Sainsbury’s supermarkets in the portfolio. But the company already owns 49% of Highbury and Dragon. And the new deal will see J Sainsbury buy the remaining 51% from Supermarket Income REIT.
The move looks set to reduce ongoing rent costs. And the directors plan to sell the remaining five stores in the portfolio. But the benefits may prove to be small overall. And that’s because the company operates more than 600 supermarkets and about 800 convenience stores.
Meanwhile, even with the dividend set to decline, the forward-looking yield is still an eye-catching 4.8% for the current trading year. But it may go higher if the stock continues to fall in this difficult market. As I write, the share price is 256p.
But any supermarket stock making it into my portfolio must have a current yield of 5%, or higher. And there must also be dividend growth forecast ahead.
For me, that kind of return is needed to compensate for the risks of holding the shares. After all, supermarket businesses are low-margin, high-volume enterprises. And they face stiff competition, which adds risks for investors.
