The Income Investor: why I back Sainsbury’s to deliver the goods

A Sainsbury’s delivery van in Aldgate, London. Photo: John Keeble/Getty Images.

The European Central Bank’s decision to raise interest rates by 25 basis points to 2.25% at its June meeting may prompt some income investors to consider avoiding UK dividend stocks. After all, it could be viewed as having potential read across for the UK.

The move to tighten monetary policy in the eurozone was undertaken in response to a rise in the bloc’s inflation rate from 1.7% in January to 3.2% in May this year. Given that UK inflation is currently only 40 basis points below that latter figure, and is due to rise to 3.7% by the end of the year, it would be somewhat unsurprising if the Bank of England followed the lead of its European counterpart.

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Indeed, two of the Bank of England’s nine Monetary Policy Committee members voted for a 25-basis point rise in borrowing costs at its June meeting, with the remainder voting for no change. This compares with an 8-1 split at the previous meeting in April.

Clearly, a rise in UK rates would likely weigh on both the economic environment and operating conditions for domestically focused firms. It could also prompt a deterioration in investor sentiment towards such companies, thereby leading to weaker share price performance over the coming months.

However, when the long-term outlook for UK-listed dividend stocks is considered, they still appear to have relative income appeal.

A temporary rise in inflation?

Indeed, UK stocks continue to offer attractive yields in some instances. Although the FTSE 100 index now yields just 3% following its 17% surge over the past year, 28 of its members offer income returns of 4% or more.

While this is still below the income return offered by the very best easy-access savings accounts and 10-year gilts, which currently stand at around 5% and 4.9%, respectively, dividend stocks offer scope for income growth over a multi-year time frame.

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In fact, the UK’s rate of inflation is expected to be 50 basis points lower at the end of 2027 than it is today. Having reached 3.7% by the end of this year, inflation is tipped to subsequently fall to 2.3% over the next 12 months.

This would take it to within 30 basis points of the Bank of England’s 2% target. It could mean that interest rate cuts, rather than rises, feature on the central bank’s agenda over the medium term.

Should they be implemented, and once time lags have passed, this could provide a boost to the economy’s performance and prompt improved operating conditions for UK-focused firms. In turn, this may allow them to generate higher profits and be able to afford growing dividends.

Source: Refinitiv as at 15 July 2026. Bond yields are distribution yields of selected Royal London active bond funds (as at 13-14 July on Trustnet), except the global infrastructure bond which is 12-month trailing yield for iShares Global Infras ETF USD Dist as at 13 July. SONIA reflects the average of interest rates that banks pay to borrow sterling overnight from each other (13 July). Best accounts by moneyfactscompare.co.uk refer to Annual Equivalent Rate (AER) as at 15 July and which exclude bonuses.

Sound fundamentals

Furthermore, plenty of FTSE 350 dividend stocks have solid fundamentals. For example, they may have dividends that are well covered by net profits. This means if the economy’s performance deteriorates in the short run, they are less likely to need to cut shareholder payouts.

Similarly, several higher-yielding FTSE 350 stocks have sound balance sheets. This may mean they are better placed to overcome a prospective temporary spike in inflation that could put pressure on consumer spending levels.

Indeed, even if rising inflation does not prompt the Bank of England to raise interest rates in the short run, it is still likely to weigh on real-terms wage growth to some extent. This could make the operating environment more challenging, especially for consumer-focused firms, in the near term.

As such, a wide range of dividend stocks may yet display heightened volatility in the coming months. This is particularly the case given broader geopolitical risks including an ongoing global trade war, conflict in the Middle East and, of course, a new UK prime minister and possible subsequent changes to fiscal policy.

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But on a long-term view, UK dividend shares have the potential to deliver attractive income returns that outpace inflation. Their sound fundamentals may also provide a degree of stability amid what remains a period of elevated economic and geopolitical uncertainty.

Solid performance

For example, FTSE 100 retailer Sainsbury (J) (LSE:SBRY) currently has a dividend yield of 4%. This is 100 basis points higher than the income return offered by the UK’s large-cap index. Furthermore, the firm’s dividend cover stands at 1.6, which suggests there is scope for shareholder payouts to rise at a similar pace to earnings growth over the coming years.

On that topic, the company’s recently released first-quarter trading update showed it is on track to meet previous financial guidance for the full year. Although sales growth in its general merchandise and clothing and Argos segments was negative, this was more than offset by a strong performance in its grocery division so that total retail sales growth amounted to 2.7%.

Encouragingly, the firm’s first-quarter trading update showed that Sainsbury’s made market share gains. This suggests that its competitive position is improving, which could prove useful during an uncertain period for consumer spending.

Similarly, the growing popularity of its Nectar loyalty programme could provide a degree of pricing power versus its rivals. This may prove particularly useful during a period of temporarily high inflation in terms of supporting profit margins, and could increase the chances of rising dividends over the coming months.

Upbeat growth potential

While Sainsbury's share price has surged 11% higher in the past month, it still has a relatively appealing market valuation. For example, it trades on a price/earnings (PE) ratio of 15.5. This compares favourably to the FTSE 100 index’s earnings multiple of 17.5 and suggests there may be upward rerating potential based on the firm’s earnings growth outlook.

Indeed, the retailer is forecast to deliver a 9% rise in earnings per share (EPS) in the current financial year. It is then expected to post a further 12% increase in EPS next year.

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Given that both figures are ahead of the FTSE 100 index’s typical mid-single digit earnings growth rate, this suggests there may be market-beating capital growth potential on offer over the long term. They also indicate that dividends per share could grow at a brisk pace given the firm’s ample dividend cover.

Risk/reward ratio

Sainsbury’s appears to have a sufficiently sound financial position through which to overcome an uncertain near-term outlook for UK consumers amid the prospect of rising inflation. Its net debt-to-equity ratio, for example, stands at 90%, while its net interest costs were covered 3.3 times by operating profits in its latest full year.

Clearly, though, its dependence on UK consumers means that its share price performance could be volatile. While groceries are a staple item, fierce competition within the sector at a time of potentially highly price-conscious consumers could act as a drag on the company’s financial performance.

And with the firm having exposure to general merchandise, which is typically a more discretionary area, it could be negatively impacted by a rise in inflation that puts pressure on real-terms wage growth over the coming months.

Sainsbury’s, though, appears to offer a favourable income investing outlook over the long run. It has an attractive yield versus the wider FTSE 100 index, ample dividend cover and scope to raise shareholder payouts amid brisk EPS growth. Its relatively low market valuation and improving competitive position, moreover, suggest that its total return potential is appealing.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.