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The surprise FTSE 100 growth stock of the year

Photo: Tesco. Fair use.

Many investors will have written off this FTSE 100 stock whose plans for global domination ended in an ignominious struggle for domestic survival, but now it’s back on form. I’m talking about Tesco (LSE: TSCO), the grocery sector big boy turned bad boy, now one of the UK blue chip stocks of the year.

Dave the rave

Tesco’s share price is up nearly 30% in the last 12 months, compared to growth of just 8.8% across the FTSE 100. This reverses years of miserable underperformance, which saw the company’s share price fall from a pre-crisis high 487p to a low of 155p, and the dividend disappear altogether.

Step forward ‘new’ boss Dave Lewis, who has had a stormer since his appointment in July 2014. He’s cleaned out the mucky Tesco stables, shutting stores, closing the HQ, grounding private jets, cutting 10,000 jobs, terminating the final salary pension scheme, offloading BlinkBox, slowing the dash for convenience stores and conclusively winning the Marmite war against his former employer Unilever.

Lidl and large

The Tesco share price rebound will still have taken many investors by surprise. It used to be one of the most popular stocks on the Fool but interest has waned after years of decline, as many investors assumed that Aldi and Lidl would continue to nibble away at its market share. However, life doesn’t go in straight lines, and at some point the German discounters had to slow.

There are signs this is happening. Lidl and Aldi are still the fastest-growing supermarkets, with annual sales up 12.2% and 10.4% respectively according to latest Kantar figures, but they’re slowing. Aldi’s sales growth is down from a high of 29.5% in August 2014. The discounters may also be flattering their numbers with a surge of new store openings.

Margin call

I shouldn’t overstate this. Tesco’s sales fell 0.4% but markets welcomed the slowing rate of decline, and started to look forward to a return to growth. October’s interims showed a third successive quarter of improving sales trends and management is now targeting operating margin of up to 4% by 2019/20, double today’s 1.9%. Fewer promotions are helping.

The Tesco recovery may well have further to run. Five consecutive years of crashing earnings per share (EPS), which reduced the figure to just 2.76p last year, are set to reverse in the year to 28 February 2017, with a whopping 171% growth. This should be followed by 33% growth in the year after, lifting EPS to 9.99p.

Tesco to go

Tesco doesn’t look cheap but it’s heading in the right direction. The current valuation of 61.8 times earning is forecast to fall to 28.1 times earnings, and 21.6 times in 2018. By then, the dividend may also be restored, albeit with an initial forecast yield of just 1.2%.

The next leg of the recovery will be tough. Wages remain squeezed. Brexit could hit the UK economy and drive up food prices. The discounters aren’t going anywhere. However, shoppers don’t hate Tesco as they once did, and its boss seems to know what he’s doing. So there’s hope.

The doom-mongers said Brexit would be a disaster for the UK, but at least the FTSE 100 surprised everybody by rebounding to new highs.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.