Is FTSE 100 Stalwart Sainsbury a Good Value?

LONDON -- Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If bought when the shares are cheap, two drivers could move the share price up:

  • Earnings growth.
  • An upward P/E rerating.

Highly successful fund manager Peter Lynch classified steady growers as Stalwarts, which he typically traded for 20% to 50% share-price gains. But whether buying for gains like that or holding for the longer term, we need to know if reliable earnings growth can continue, and whether the shares are cheap.

Seeking durable growth
Not all companies achieve stable growth, as you can see by the aggregate performance of those in London's premier FTSE 100 index (UKX), where the compound annual earnings-growth rate has been just 0.7% over the past five years:

Year to June

2007

2008

2009

2010

2011

2012

FTSE 100 index

6,608

5,626

4,249

4,917

5,946

5,571

Aggregate earnings per share

537

503

427

397

527

557

Consistent, cash flow-backed growth in profits is a promising characteristic in today's markets, so for this series, I'm examining firms with annual earnings growth between 4% and 20%.

One contender is Sainsbury (LSE: SBRY  ) , which is Britain's third-largest supermarket chain. This table summarizes the company's recent financial record:

Year to March

2008

2009

2010

2011

2012

Revenue (millions of pounds)

17,837

18,911

19,964

21,102

22,294

Adjusted earnings per share (in pence)

19.6

21.2

23.9

26.5

28.1

So earnings have grown at an equivalent 9.4% compound annual growth rate, putting the company in the Stalwart category.

Sainsbury posted an upbeat half-year-results statement on Nov. 14, declaring a 9.4% increase in underlying earnings per share. Things are going well -- so well, in fact, that the firm reckons it now commands a 16.7% share of the nation's grocery market, the highest for almost a decade, and a feat achieved after what is now 31 consecutive quarters of like-for-like sales growth.

The firm has about 1,063 stores, around 440 of which are of the smaller convenience format and each one of them battling for customers at the expense of the competition. The skirmish-du-jour is in fresh food, and Sainsbury's master plan is to source its fresh produce from Britain, which, according to the directors, "will help develop British farming and protect livelihoods, while reducing food miles and delivering fresh, healthy, nutritious food to the table." That sounds like a jolly good idea to me. If the customers like it, further earnings growth seems likely.

Sainsbury's earnings growth and value score
I analyze five indicators to determine whether earnings growth can continue and if the shares offer good value:

1. Growth: revenue, earnings, and cash flow all growing steadily. 5/5.

2. Level of debt: net gearing of around 40% with borrowings about 2.7 times earnings. 3/5.

3. Outlook and current trading: good recent trading and a cautiously positive outlook. 4/5.

4. Enterprise value to free cash flow: a trailing 19 or so; above historic growth rates. 2/5.

5. Price to earnings: trailing at around 12. Just above historic rate of earnings growth. 3/5.

Overall, I score Sainsbury 17 out of 25, which encourages me to believe this stalwart can continue earnings growth that out-paces that of the wider FTSE 100, and that the shares look fairly priced when considering the dividend, the FTSE's price-to-earnings ratio of around 11, and the firm's growth predictions.

Foolish summary
Revenue, earnings, and cash flow have all grown steadily, and debt seems under control. Given the predictions for growth, the shares reflect the encouraging outlook by fairly pricing the company.

Right now, forecasted earnings growth is 6% for 2014, and the forward P/E ratio is about 11 with the shares at 347 pence. Considering that and the other factors analyzed in this article, I don't think that Sainsbury is the kind of mispriced stalwart I'm searching for, so it can stay on watch, for now.

Sainsbury is one of several steady-earnings-growing stalwarts on the London stock exchange, each with the potential to deliver significant capital appreciation when purchased at sensible prices.

If you, like me, are serious about capital gains, I recommend you now read "The One U.K. Share Warren Buffett Loves," which is a time-limited Motley Fool free report discussing the British Stalwart that has recently attracted some of the American superinvestor's billions.

This one U.K. share ticked the boxes for Warren Buffett on growth prospects and cheapness, and maybe it will for you, too. Click here to access the report while you still can.


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