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Is Tesco plc Set For Electrifying Earnings Growth In 2014?

Today I am looking at the earnings outlook of Britain’s premier supermarket Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) for the coming year.

Tough retail market set to endure in 2014

Tesco noted in its interims this month that “continuing pressures on UK household finances have made the grocery market more challenging for everyone since the summer,” creating a worrying harbinger for the coming year. On a like-for-like basis, Tesco’s UK sales dropped 1.4% during September-November, worsening from the flat performance during the prior three-month period.

The retailer’s claims of cross-market difficulties are to some extent true, with aggregated growth for the country’s largest chains of 1.7% in the 12 weeks to 9th November, down from 1.8% in the 12 weeks to October 12, according to Kantar Worldpanel. This also compares markedly with expansion of 3.3% and 3.4% in the two periods prior to these.

Indeed, the effect of enduring pressure on consumers’ wallets is hampering growth across the mid-tier grocery segment, and driving customers into the clutches of budget retailers such as Lidl and Aldi. As inflation continues to broadly outpace salary increases, the stratospheric market share expansion of these chains is likely to continue to weigh on Tesco and its peers.

Happily, Tesco continues to grow its presence in the internet marketplace, however, and the firm currently controls approximately 48% of the market. The company is investing heavily here to underpin future growth, and last month announced plans to launch a same-day delivery system across the country in coming months. Tesco also opened its sixth online-only store in recent weeks.

Still, all of the UK’s major online operators are gearing up for an intensifying fight to consolidate and grow their position in this high-growth market. The much-publicised entry of Wm. Morrison into the online space is set to come to pass next month, while the Co-Operative Group is currently trialling ‘click-and-collect’ services in Greater Manchester.

The City’s number crunchers expect Tesco to follow last year’s 11% earnings decline with a further 6% fall in the 12 months concluding March 2014, to 31p per share. But the supermarket’s ongoing turnaround strategy is expected to yield positive results from 2015, when a 3% rise to 31.9p is anticipated.

These projections leave the firm dealing on P/E ratings of 10.5 and 10.2 for 2014 and 2015 correspondingly, just above the bargain yardstick of 10 times forward earnings.

As sales continue to slump at its stores, and the fast-growing online and convenience sectors become more congested, Tesco’s transformation strategy could take longer to gain traction that initially envisaged. Still, the firm’s considerable financial clout and re-focussed attention on its core UK markets could make it a winning bet for long-term investors, particularly as conditions in the wider retail environment eventually improve.

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Regardless of Tesco’s uninspiring near-term earnings outlook, analysts still expect the business to keep last year’s 14.76p per share full-year dividend in tact for fiscal 2014, before building the payout to 15.3p the following year. If completed, these payments would translate to yields of 4.4% and 4.6% respectively, easily surpassing the 3.3% forward average of the FTSE 100.

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Royston does not own shares in any of the companies mentioned in this article. The Motley Fool owns shares in Tesco and has recommended Wm. Morrison.