DIY group Kingfisher (LSE: KGF) enjoyed a 3% rise in like-for-like sales during the three months to 31 July, despite sales falling by 3.2% in France as a result of strike action and bad weather.
Kingfisher, which owns B&Q and Screwfix, said that UK like-for-like sales rose by 7.2% during the period. Chief executive Véronique Laury said that the EU referendum had created uncertainty but that as yet, there was “no clear evidence of an impact on demand.”
The shares have rebounded strongly since hitting a low of 306p after the referendum. Kingfisher now trades on a 2016/17 forecast P/E of 16 and offers a prospective yield of 2.9%.
That may not seem especially cheap, but it’s worth remembering that at the end of last year, Kingfisher had net cash of £546m and an operating margin of 5%. The firm’s ability to generate free cash flow has enabled it to buy back 44m shares over the last six months, returning £150m to shareholders and supporting earnings per share growth.
Kingfisher looks like a solid buy to me. But before making a decision, it’s probably worth asking whether popular supermarket stocks such as Tesco (LSE: TSCO) and J Sainsbury (LSE: SBRY) might offer more upside potential.
Cyclical risk?
One disadvantage of Kingfisher’s business is that it’s cyclical. Spending on home improvements is linked to the state of the economy and the housing market. In contrast, supermarkets are considered to be defensive stocks. Our shopping habits don’t change much, even in a recession.
The only problem with this logic is that while Kingfisher has strong market share and few serious competitors in the UK, supermarkets are currently locked in a brutal price war. Profit margins at UK food retailers have crumbled over the last couple of years. Tesco reported an adjusted operating margin of just 1.9% last year, while for Sainsbury the figure was 3%.
What about dividends?
Supermarkets have historically been popular dividend stocks, but all the listed supermarkets have cut their payouts over the last couple of years. Tesco has been by far the biggest dividend disaster. The firm’s payout was suspended in 2015 and no payout was made last year.
Tesco boss Dave Lewis has indicated his main focus is on gaining market share and reducing debt levels. Analysts’ forecasts suggest that Tesco’s dividend may not be reinstated until the 2017/18 financial year.
Investors owning Tesco for income will need to take a long-term view and Sainsbury may be a better option. The store trades on a modest valuation of 11 times forecast earnings and offers a prospective yield of 4.5%.
Although the group’s £1.4bn acquisition of Argos owner Home Retail Group could be a drag on profits, Sainsbury’s strong balance sheet and stable sales suggest to me that this risk may be worth taking.
In my opinion, both Sainsbury and Kingfisher could be good value at current prices. I suspect both are likely to outperform Tesco over the short term, although the longer-term outlook is less certain.