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After dodging a legal bullet, is Tesco plc now a screaming buy?

Photo: Tesco. Fair use.

Last week’s announcement that Tesco  (LSE: TSCO) had reached an agreement with the Serious Fraud Office to pay a substantial fine in return for avoiding prosecution for accounting irregularities should put an end to the miserable affair that has dogged the company over the last few years.  

In addition to coughing up £129m, Tesco is also required to compensate those investors who purchased its shares and bonds on or after August 29 and held them until September 22 when news of the scandal broke. When associated costs are factored-in, this means a total exceptional charge of £235m.

Whatever their feelings on the ethics of this arrangement, I doubt many would argue that this development is negative for Tesco and its shareholders. By avoiding a potentially even more costly legal process, CEO Dave Lewis and senior management can now get on with continuing to turn the company around.

So is Tesco now a buy?

Not necessarily. Despite becoming a more streamlined beast under Lewis’s stewardship, Tesco still faces many of the same problems as its listed peers Sainsbury’s and Morrisons. Rising inflation and slowing wage growth are now combining to make shoppers more cost-conscious than ever before. The triggering of Article 50 and the political posturing that inevitably follows won’t help matters.

There’s also the small issue of its proposed ‘merger’ with Booker needing to be approved. Given the strong likelihood of Tesco being required to dispose of a large number of its smaller (and increasingly popular) Express stores to satisfy the Competition and Markets Authority, it’s unsurprising if this deal doesn’t sit well with all shareholders.  

With a price-to-earnings (P/E) ratio of 25 right now, shares in the UK’s biggest retailer certainty aren’t cheap either. A screaming buy? Perhaps not.

Then again…

If all this sounds a bit bleak, perhaps it’s worth reflecting on the many attractions to owning shares in the £15bn cap.

For one, Tesco still commands an enviable market share (27.9% compared to Sainsbury’s 16.5%, according to Kantar Worldpanel), suggesting that most consumers are willing to overlook the company’s questionable past behaviour. This, combined with the fact that Tesco operates in a non-discretionary market makes it a far more defensive investment proposition than most retailers.  

In spite of the steep valuation attached to its shares, a PEG ratio of just 0.8 for this year (falling to just 0.6 in 2018) also indicates that prospective investors will be getting a lot of growth for their money, assuming analyst earnings estimates can be met. Things should become a lot clearer on this front when the company reports its full-year results to the market in just over a week (April 12).

With its balance sheet starting to look healthier, Tesco’s recent pledge to resume paying dividends from the next financial year is another bonus and should bring a smile to those who have stayed with the company throughout the accounting fiasco. A potential 3% yield in two years’ time won’t have investors clamouring for the shares as markets open but — as the company itself frequently reminds us — “every little helps”.

So long as expectations over future share price performance remain grounded in reality, I think Tesco represents a reasonable bet for the long term. 

Make no mistake

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.