Is Tesco PLC A Super Income Stock?

Does Tesco PLC (LON: TSCO) have the right credentials to be classed as a very attractive income play?

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It’s been a rough few years for investors in Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US). Not only have shares fallen by 20% over the last three years (while the FTSE 100 has risen by 11%), the company has seen its market share fall and its strategy called into question.

Indeed, during the last three years Tesco has come under increased pressure from discount supermarkets such as Aldi and Lidl, while sector peer J Sainsbury has delivered an impressive streak of sales growth. Tesco, it seems, is struggling for direction in the post-Terry Leahy years. However, does that mean that it is no longer an attractive income play? Is Tesco no longer a super income stock?

As a result of the difficulties it has experienced, Tesco has not increased dividends per share over the last three financial years. This is disappointing for income-seeking shareholders but is a prudent response to the challenging trading conditions experienced by the company, with capital being best directed at reinvesting in the business rather than increasing the amount paid out to shareholders.

Despite this dividend freeze, Tesco still yields 4.6%. Of course, this is at least partly due to the falling share price but it means that Tesco’s yield is considerably higher than the FTSE 100 average of 3.5%. Crucially, it remains well ahead of inflation and significantly better than a typical high-street savings account.

While Tesco is expected to increase dividends per share in future, the rate at which this is undertaken is set to lag many of its FTSE 100 peers. Dividends per share are forecasts to increase at an annualised rate of just 1% over the next three financial years. While this is disappointing, the growth rate could turn out to be somewhat higher, since Tesco continues to be rather mean when it comes to the proportion of profits paid out as a dividend.

Of course, this has always been the case with Tesco, as its vast capital expenditure programmes require capital to be reinvested in the business (rather than paid out to shareholders). However, with Tesco shifting its focus online and to smaller stores (rather than larger stores that cost more to build), capital expenditure should fall in future, meaning a greater proportion of profit could be paid out as a dividend. This could mean that dividends per share increase at a faster rate than is currently priced in.

So, with a yield of 4.6% and the scope to increase the dividend payout ratio, Tesco remains a super income stock. While the company looks set to continue to experience challenging trading conditions, it could prove to be a strong income play in the long run.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter owns shares in Tesco. The Motley Fool owns shares in Tesco.

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