Owning shares in Tesco (LSE: TSCO) and Barclays (LSE: BARC) has been a frustrating experience over the last few years. Numerous false dawns have been followed by plummeting share prices and renewed losses.
A seemingly endless supply of bad news has left both companies trading at multi-year lows. Tesco shares are trading at levels last seen 19 years ago! Meanwhile, Barclays has lost 40% of its market value over the last year.
Will either of these companies ever regain their status as blue chip dividend stocks?
Will patience be rewarded?
I can understand why many investors have lost faith in banking stocks, given the on-going series of losses and misconduct fines they’ve reported. So far, Barclays has set aside £7.4bn against the cost of PPI claims alone. That’s a staggering amount.
However, I think the real problem is that many of us bought back into bank stocks too soon.
In my view, we’re only just starting to see the likely start of the big banks’ turnaround. Barclays’ Q1 results showed little improvement on the same period last year. The group’s return on tangible equity was just 3.8%, down from 4% during the first quarter of last year.
Barclays’ turnaround rests on chief executive Jes Staley delivering on his commitment to dispose of non-core assets. This plan does have some promise. Barclays’ core operations generated a return on tangible equity of 9.9% during the first quarter. Barclays’ flagship UK operations did even better, with a 20.5% return on tangible equity.
As things stand, I believe Barclays is a reasonably good buy for value investors. The bank’s shares trade at a 42% discount to their tangible net asset value. Barclays has a 2016 forecast P/E of 14, falling to just 8.3 in 2017.
The big risk is that these earnings forecasts will continue to fall. Broker forecasts for Barclays’ 2016 earnings have fallen by more than 50% over the last year.
An uncertain outlook plus last year’s 50% dividend cut means that, in my view, investors buying Barclays shares for income will need to look several years ahead. Taking this patient approach may turn out to be very profitable, but it could also be risky.
Good progress, but what next?
I think that Tesco’s chief executive, Dave Lewis, has made decent progress since he took charge in 2014. The group’s net debt has been halved, several overseas businesses have been sold, and Tesco’s UK business has been overhauled.
Tesco’s UK sales volumes rose by 3.3% during the final quarter of last year, while transaction numbers rose by 2.8% during the period. Like-for-like sales were 0.9% higher. This represents good progress, given the intense price war that’s currently taking place in the supermarket sector.
Although the new Amazon Fresh service will provide an additional challenge, I believe now could be a fairly good time to buy into the Tesco recovery story.
Tesco stock trades on 16 times 2017/18 forecast profits, with a forecast yield for next year of 2.4%. Although these figures don’t indicate an outright bargain, I expect steady earnings growth as net debt continues to fall. This should free up more cash flow for shareholder returns.
