2 overlooked bargain stocks for growth and income hunters

Sainsbury's

Shares of J Sainsbury (LSE: SBRY) rose by 2% on Monday morning, after press reports over the weekend revealed that the UK’s second-largest supermarket is considering a £130m bid for convenience store group Nisa.

In the wake of last year’s £1.4bn acquisition of Argos, Sainsbury’s investors may be wondering if the company is simply throwing money around and hoping for growth. Today, I’ll explain why I disagree with this view and why I continue to rate the supermarket as a buy.

A logical move

Acquisitions can be risky, especially when they appear to be made in response to the actions of competitors. In this case, it’s hard not to compare Sainsbury’s mooted deal to buy Nisa with Tesco‘s planned deal to acquire wholesaler Booker, which owns the Budgens and Londis chains.

However, I don’t think this is simply a copycat move. Convenience stores are currently one of the most profitable areas of growth for big supermarkets. Sainsbury has already talked about the possibility of franchising new stores rather than acquiring them. The Nisa deal would effectively be just that, bringing 2,500 independently-owned shops under the supermarket’s brand.

It’s important to remember that Nisa doesn’t own any of these shops — it owns the branding and the wholesale operation which stocks them. I’d imagine that by integrating these extra stores into Sainsbury’s existing supply chain, worthwhile cost savings would be possible.

I remain attracted to Sainsbury’s stock. Early signs suggest to me that the Argos deal should help to increase the profitability of the group’s large stores, and I can see the logic of a deal to acquire Nisa.

The supermarket group’s shares currently trade on a 2018 forecast P/E of 13.6 with a prospective yield of 3.8%. That’s significantly cheaper than both of its main listed rivals. In my opinion, this discount is unwarranted and makes the shares a buy.

A better alternative?

On the other hand, if you want to profit from convenience store growth, a better option might be to invest directly in convenience stores. If this appeals, you may want to consider McColl’s Retail Group (LSE: MCLS).

As it happens, McColl’s is Nisa’s largest customer. It’s also the third-largest owner of convenience stores in the UK, with more than 1,300 stores. Growth has been steady, with sales rising from £844.7m in 2012 to £950.4m last year. After-tax profit has risen from £10.3m to £13.9m over the same period. However, the acquisition of 298 stores from the Co-op last year is expected to drive a step change in sales and profits, which are expected to reach £1,138m and £20m respectively this year.

Analysts expect these figures to translate into earnings per share growth of about 10% this year and a whopping 29% in 2017/18. This leaves the group’s stock on a forecast P/E of 11 for this year, falling to a P/E of 9.1 in 2018.

McColl’s other attraction is its generous dividend. The shares currently offer a forecast yield of 5%. The payout should be comfortably covered by earnings and the yield is higher than anything available from the three big supermarkets. There’s also the possibility that the group will become a bid target itself. I think these shares are worth a look at current levels.

Is this today’s top income growth buy?

I’m bullish about the outlook for Sainsbury and McColl’s. But here at Motley Fool HQ, our expert analysts believe they’ve found a better alternative. They believe that this FTSE 250 retail stock could rise in value by 200% over the coming years.

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More reading

Roland Head owns shares of J Sainsbury and McColl’s Retail Group. The Motley Fool UK has recommended Booker. 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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