Why Tesco PLC’s Shares Should Be Dealing 70% Lower!

Royston Wild explains why Tesco PLC (LON: TSCO) is due for a sharp share price correction.

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Shares in grocery colossus Tesco (LSE: TSCO) proved remarkably resilient in January, with the stock shrugging off the worst of the shivers currently affecting financial markets.

This will come as rare relief to the battered supermarket’s shareholders, Tesco’s share price having conceded 20% during 2015 and a whopping 55% in the three years to the close of December. Indeed, the Cheshunt firm’s share price has risen by 14% since the bongs greeted the start of 2016, and there is some logic to this bump.

While Tesco still has some exposure to foreign climes across Asia and Europe, it could be argued that the company’s overwhelming focus on the UK — helped further by its well-publicised overseas divestments in recent times — makes the retailer more immune to the troubles traversing emerging markets.

However, I believe there is still plenty of mud in the water over at Tesco to warrant a fresh share slide.

Competitive pressures ‘on the up’

Of course a promising post-Christmas trading update during January did Tesco’s share price little harm, either.

The company beat market expectations with a 1.1% uptick in UK like-for-like sales in the 19 weeks to January 9th, with sales rising on the back of additional price reductions and improved customer service.

Still, this rare uptick fails to conceal the fact that 2015 represented another disastrous year for Tesco’s checkouts. Researcher Kantar Worldpanel advised last month that a further 2.7% sales slide in the three months to January 3rd drove the retailer’s market share down to 28.3%, a drop of 80 basis points from the corresponding point last year.

And I believe the trading environment is set to get a lot tougher for Tesco, as discounters Lidl and Aldi aggressively expand on the ground and in cyberspace. Indeed, the latter launched its online wine service just a few weeks ago.

US internet giant Amazon is also ramping up its British grocery delivery service, a strategy that would be greatly enhanced should talk of a swoop for online grocer Ocado come to fruition.

Meanwhile, the launch of Stelios Haji-Ioannou’s easyFoodstore this week adds another layer of intrigue to the intensifying ‘price wars’ enveloping the sector.

Time to find the exit?

Given these problems the City expects Tesco to endure a fourth consecutive earnings slide in the 12 months to February 2016, this time by a colossal 45%.

This reading leaves the supermarket dealing on a P/E multiple of 34.4 times, which is well above the benchmark of 10 times or below, and indicates that Tesco carries a high level of investment risk.

A subsequent re-rating of Tesco’s stocks would leave the business dealing at 51.7p per share, representing an eye-watering 70% discount from current prices of 170.5p.

With trading conditions in the UK grocery becoming ever-more difficult, it appears as if Tesco will have to continue implementing earnings-smashing price cuts just to keep sales levels stagnant. And as the negative trading data keeps on rolling in, I reckon the Cheshunt firm is in danger of suffering a severe share price drop as investors increasingly head for the doors.

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

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