Does Tesco PLC Pass My Triple-Yield Test?

Roland Head explains why Tesco PLC (LON:TSCO) shares are a screaming buy at today’s price.

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Like most private investors, I drip feed-money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.

Although the FTSE 100 is up 87% from its March 2009 low, and the wider market is no longer cheap, one company that definitely looks cheap at the moment is Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US).

Is the UK’s biggest supermarket a value buy?

The triple-yield test

To gauge the affordability of a share for my portfolio, I like to look at three key trailing yield figures –the dividend, earnings and free cash flow yields — and compare them to the returns available from other assets. I call this my triple yield test:

Tesco Value
Current share price 303p
Dividend yield 4.9%
Adjusted earnings yield 11.1%
Free cash flow yield 6.0%
FTSE 100 average dividend yield 2.8%
FTSE 100 earnings yield 5.8%
Instant access cash savings rate 1.5%
UK 10yr govt bond yield 2.8%

A share’s earnings yield is simply the inverse of its P/E ratio. Tesco’s earnings yield of 11.1% is impressive, but it is worth remembering that the firm’s profit margins are expected to fall this year and it may incur further exceptional costs, too.

Similarly, although Tesco’s generous 4.9% dividend yield is covered by its trailing twelve month free cash flow yield of 6.0%, this was only made possible because of a raft of property and business disposals last year. We’ll have to wait until April 16 to see if Tesco has managed to preserve free cash flow cover for its full-year dividend in 2013/14.

tescoIs Tesco a buy?

I remain bullish on Tesco and believe its vision for an integrated online and in-store business could deliver big long-term benefits.

Tesco recently revealed that it is making a profit of around 5% on its home delivery service, which analysts had previously suspected was loss making. The firm’s ability to ‘touch’ customers at every point — online, convenience and supermarket — is unparalleled in the UK supermarket sector, as is the insight into customer’s shopping habits provided by its Clubcard loyalty scheme, which has around 16 million active cards.

Looking ahead, Tesco has promised to deliver fewer promotional offers and more permanently lower prices, and will also focus on other ways to add value for customers. A recent example is the firm’s decision to make all purchases made with a Clubcard — however small — count towards future discounts on fuel purchases, up to a maximum of 20p per litre. This should help drive online non-food purchases and encourage in-store loyalty. 

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.

Both Roland and The Motley Fool own shares in Tesco.

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