What are the long-term prospects for Tesco (LSE: TSCO)?
I'm always searching for shares that can help ordinary investors like you make money from the stock market.
Right now I am trawling through the FTSE 100 (UKX) and giving my verdict on every member of the blue-chip index.
I hope to pinpoint the very best buying opportunities in today's uncertain market, as well as highlight those shares I feel you should hold… and those I feel you should sell!
I'm assessing every share on five different measures. Here's what I'm looking for in each company:
1. Financial strength: low levels of debt and other liabilities;
2. Profitability: consistent earnings and high profit margins;
3. Management: competent executives creating shareholder value;
4. Long-term prospects: a solid competitive position and respectable growth prospects, and;
5. Valuation: an under-rated share price.
A look at Tesco
Today I'm evaluating Tesco (LSE: TSCO), a UK-based multinational retailer that also engages in general merchandise, telecom, banking and insurance services, which currently trades at 346p. Here are my thoughts:
1. Financial strength: Tesco has relatively modest gearing with net debt of 52% of tangible equity. The balance sheet is solid backed up by property assets worth £36bn and interest cover of 15. I do not foresee any problems with liquidity as free cash flow generation has been strong -- averaging £2.5bn the past three years -- and will only improve with the company's intention to decrease capital expenditures and keep it below 5% of sales the next few years.
2. Profitability: Tesco's performance this past decade has been impressive, consistently delivering ROE's of 16%, compounding sales by 10% and earnings by 12% annually, while keeping operating margins at 6%. For the past five years, international sales and operating profits have grown by 14% and 8% per annum respectively. Also, the company's online retail business has been highly successful, with Tesco now the world's largest and most profitable online grocer with revenues of well over £2bn. Moreover, the company has profited from its strategy of releasing the value of its property portfolio, gradually selling off property assets the last few years.
3. Management: After 14 years, CEO Terry Leahy has stepped down and has been replaced by Philip Clarke on March 2011. Admittedly, Leahy will be a tough act to follow -- during his tenure, sales have more than doubled and earnings have tripled, while the business has expanded into 13 countries, in the process becoming the world's third largest retailer. Nevertheless, Philip Clarke appears to be an able replacement -- he has been with Tesco for 36 years and was a huge part in the company's expansion into the international market.
4. Long-term prospects: Despite its recent struggles, Tesco still leads the UK with a market share of 30%, followed by Walmart's (NYSE: WMT.US) ASDA on 17%, Sainsbury's (LSE: SBRY) 16%, and William Morrison's (LSE: MRW) 12%. It has invested £1bn to revitalise UK operations, while its international business has been growing rapidly and now accounts for 32% of revenues. In fact, the company has managed to become the leader in most of its markets outside the UK.
5. Valuation: Tesco's current market cap of £28bn is significantly lower than the current market value of its properties pegged at £36bn. Its forward price-to-earnings (P/E) ratio of 10 is at the lower end of its 10-year historical P/E ratio, and it currently gives an attractive dividend yield of 4.39%.
My verdict on Tesco
Although past performance is not indicative of future results, I believe Tesco can duplicate last decade's performance. Its fundamentals remain solid despite recent struggles in the UK, while its international operations, burgeoning general merchandise and retail services -- banking, telecom and online store -- and property development strategy provide huge growth potential. Furthermore, the market value of its properties provides a significant margin of safety while its stable dividend yield, which has been growing by 10% for the past 10 years by the way, will reward investors while waiting.
So overall, I believe Tesco at 346p looks like a buy.
More FTSE opportunities
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In the meantime, please stay tuned for my next verdict on a FTSE 100 share.
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> Zarr does not own shares in any of the companies mentioned. The Motley Fool owns shares in Tesco.
