The Sainsbury’s (LSE:SBRY) yield of 5% beats the 3.5% FTSE 100 average by a large distance. But should I buy this dividend stock given the threat of surging inflation to Britain’s grocers?
Tesco comes under pressure
The scale of the danger was illustrated by rival Tesco’s (LSE:TSCO) full-year trading update on Wednesday. Then it said that adjusted operating profit will fall to between £2.4bn and £2.6bn in the current year (to February 2023). That’s down from £2.65bn in the prior period.
Tesco said that this reflects the damage to earnings that will come from rising levels of cost inflation, investment in keeping prices low to remain competitive, and the return of more normal sales levels as the pandemic recedes.
Inflationary dangers
Inflation is a real threat for grocery shares like Sainsbury’s and Tesco given their wafer-thin profit margins. Indeed, the retail underlying operating margin at Sainsbury’s slumped to 3.37% in the first half, down 40 basis points year on year.
At the same time, Sainsbury’s needs to spend to stay in reach with its established rivals like Tesco and the discounters Lidl and Aldi.
The business has parked hundreds of products under its Price Lock guarantee to keep shopper costs low. It’s likely going to need to keep slashing prices at the expense of margins to stop cash-strapped shoppers deserting for its cheaper rivals.
A cheap FTSE 100 stock
On the plus side the huge amounts Sainsbury’s has spent on its online business is paying off. Digital sales jumped 92% in the 16 weeks to 8 January on a two-year basis. It suggests that the FTSE 100 firm could really make a splash in the fast-growing e-grocery industry.
At the same time Sainsbury’s shares look dirt cheap. Today they command a forward price-to-earnings (P/E) ratio of 10.7 times, making it much cheaper than Tesco. The latter sports a reading of 12.3 times for this year.
Dividends looking good!
And talking once more of dividends, I like the fact that the predicted full-year payout of 12.2p per share for Sainsbury’s looks quite well protected.
That City estimate is covered 1.9 times by anticipated earnings. This is roughly in line with the widely-accepted security benchmark of two times.
What’s more, in January Sainsbury’s said that free cash flow remains “strong”. It also said that it should hit its net debt reduction ahead of target, in an extra boost to the balance sheet.
Risk vs reward
All that being said, Sainsbury’s isn’t a FTSE 100 share I’d buy today.
High inflation will likely prove to be a temporary problem. What won’t, however is the intensifying threat posed by its competitors on the ground and in cyberspace.
Aldi and Lidl are hastily expanding their store footprints across the UK. Amazon is also investing heavily in stores as well as its online operations. And all of the country’s major grocers are bulking up their online operations too.
So I’ll avoid Sainsbury’s despite its cheap share price and huge dividend yields. There are many other cheap UK shares I’d rather buy right now.