Tesco’s (LSE: TSCO) shares entered 2015 with a strong tailwind behind them. Between the first week of January and the first week of April, the company’s shares gained 18%, outperforming the wider FTSE 100 by more than 10%.
However, since the beginning of April, investor sentiment has waned and during the past three months Tesco has declined by 18%. That said, year to date the company is still outperforming the wider FTSE 100 by 8%. It’s not all bad news.
The question is, should investors take advantage of Tesco’s recent declines and buy the dip?
Not much to go on
Tesco’s gains during the first half were driven by investors’ optimism; there was little in the way of news released over the period.
After Tesco issued its key Christmas trading and strategy update at the beginning of January, investors had no significant news until the group’s preliminary results released at the end of April.
But despite the fact that there was no significant news issued over the period, Tesco’s shares remained in demand and were, at one point, trading at a forward P/E of 28.
So, in some respects Tesco got ahead of itself during the first quarter of this year as investors rushed to buy the company’s shares in anticipation of improved trading.
Tesco’s shares have now wiped out most of their gains this year and the company’s valuation has declined. The group’s forward P/E has fallen to 24.
Time to buy?
Even after Tesco’s recent declines there aren’t many reasons to buy the company’s shares at present levels.
Indeed, the group’s turnaround is still in its early stages. Like-for-like sales remain under pressure, declining 1.3% during the 13 weeks ended 30 May 2015. Gross gearing stands at 180% and the company’s cost-cutting and restructuring programme has only been in place for a few months.
That said, Tesco is moving in the right direction. Like-for-like volumes rose 1.4% during the 13 weeks ended 30 May 2015, bidders have expressed interest in the group’s overseas businesses and management have stopped Tesco’s store expansion programme in its tracks.
Difficult to justify
Overall, it’s difficult to justify Tesco’s current premium valuation. A forward P/E of 24 is still expensive for a company that’s not expected to return to growth until next year. Moreover, City analysts expect Tesco’s dividend yield to fall to 0.4% next year.
However, Tesco is expected to return to growth during 2017. Analysts are forecasting earnings per share growth of 32% for 2017 and based on these numbers, the company is currently trading at a 2017 P/E of 17.7.
These forecasts may look impressive but, for the time being, they are just that, forecasts.
Until Tesco shows concrete signs of a recovery, the market will remain sceptical. That’s why I’m not a buyer of Tesco at present levels, as there’s a chance the company’s shares could fall further.
