Is Tesco plc heading back to 300p?

Roland Head gives his view on the latest figures from Tesco plc (LON:TSCO).

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Shares of Tesco (LSE: TSCO) fell by 3.5% to 188p this morning, despite the UK’s largest supermarket reporting its first like-for-like annual sales growth for seven years.

Sales, excluding VAT and fuel, rose 4.3% to £49.9bn, while like-for-like sales were 0.9% higher. Tesco’s adjusted operating profit lifted 24.9% to £1,280m. Operating cash flow from the group’s retail business rose 9.1% to £2,279m, which helped fund a 27% reduction in net debt to £3.7bn.

A notable success was that Tesco’s underlying operating margin rose from 1.8% to 2.3%. This suggests to me that the group’s target of 3.5-4.0% by 2019/20 may be achievable.

Not all good news

Unfortunately there was a downside to these polished headline figures. The group’s reported pre-tax profit fell 39.1% to £145m, on the back of £235m payments made to the Serious Fraud Office and the Financial Conduct Authority.

Although the 2.3% improvement in Tesco’s operating margin is good news, is still lower than those of its smaller rivals Wm Morrison Supermarkets (2.9%) and J Sainsbury (3.1%).

There’s no dividend for last year, but as previously promised payments will be restarted during the current financial year. Tesco says it is targeting medium-term dividend cover of two times earnings per share. Analysts’ forecasts prior to today’s results suggested a payout of 3.26p per share for 2017/18. This would give a yield of 1.7% at the current share price of 188p.

Don’t underestimate this supertanker

Tesco is the supertanker of the UK supermarket sector. It’s by far the biggest and is likely to take longer to turnaround. But once moving in the right direction, I believe the group could gain surprising momentum.

Chief executive Dave Lewis is keen to remind shareholders that he’s planning for the long term, not just trying to apply quick fixes. An example of this is the money being spent on increasing the number of big stores that are owned freehold by Tesco, rather than leased.

The group increased its proportion of freehold stores from 50% to 57% last year. Over the last 13 months, Tesco has bought back 23 stores, reducing the firm’s annual rent bill by £36m.

A second example of long-term planning is Tesco’s proposed acquisition of food wholesaler Booker Group. This £3.7bn deal has met with opposition from some big investors, but I’m impressed by the long-term growth potential it seems to offer. Combining with Booker would see Tesco increase its share of the lucrative convenience store market and become a major wholesaler to the restaurant trade.

Will Tesco get back to 300p?

On a short-term view, Tesco stock looks fully priced to me. At 188p, it trades on a P/E of 19 times 2017/18 forecast earnings, with a prospective yield of just 1.7%.

But if the firm can hit its target of a 3.5-4.0% operating margin by 2019/20 and deliver modest sales growth, then I estimate that earnings of 16-20p per share might be possible. Together with an increased dividend payout, this would make a 300p share price seem quite reasonable.

In my view, Tesco looks an attractive long-term buy at current levels, but investors looking for short-term profits may want to shop elsewhere.

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.

Roland Head owns shares of Tesco and J Sainsbury. The Motley Fool UK has recommended Booker. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

How much does an investor need in a Stocks and Shares ISA to earn £1,000 a month in passive income?

A Stocks and Shares ISA's a valuable asset for investors. Not having to pay dividend tax can be a big…

Read more »

Investing Articles

9% dividend yield! Could buying this FTSE 250 stock earn me massive passive income?

Assura looks like an outstanding stock for dividend investors to consider. But is the 9% dividend yield the passive income…

Read more »

Man putting his card into an ATM machine while his son sits in a stroller beside him.
Investing Articles

Why I think this month could be critical for the Lloyds share price!

Our writer explains why he thinks the bank's 2024 results will have a significant impact on the short-term direction of…

Read more »

British Pennies on a Pound Note
Investing Articles

This former penny share has soared 168%. Is the best yet to come?

When Christopher Ruane saw a penny share as a potential bargain last year, he was spot on. So having not…

Read more »

Mature couple at the beach
Investing Articles

£20k in an ISA? Here’s how it could generate £1 of passive income every hour — forever

With a long-term approach, Christopher Ruane explains how an investor could aim to earn a pound per hour in passive…

Read more »

One English pound placed on a graph to represent an economic down turn
Investing Articles

FTSE shares: overpriced or still a bargain?

Christopher Ruane reckons a storming FTSE 100 performance of late doesn't tell us much about whether there are still possible…

Read more »

Blue NIO sports car in Oslo showroom
Investing Articles

Would an investor have made money investing £2k in NIO stock 5 years ago?

Our writer looks at how NIO stock has performed over recent years and weighs the bull and bear cases as…

Read more »

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

5 steps to start buying shares with £5 a day

In a handful of steps, our writer explains how someone new to the stock market could start buying shares for…

Read more »