Why I’d buy Tesco plc and avoid this FTSE 250 ‘growth’ stock

Roland Head explains why he’s betting on market-beating growth 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.

In recent years, many defensive stocks have been among the best performers in the market. Their consistent growth, high margins and steady dividends have been a welcome relief from the slumps seen in sectors such as outsourcing, oil and gas, mining and supermarkets.

One exception to this trend has been FTSE 250 consumer goods firm PZ Cussons (LSE: PZC). Shares in the owner of brands such as Imperial Leather, Carex and Sanctuary have fallen by 14% over the last five years, during a period when FTSE 100 rival Unilever has climbed 75%.

PZ Cussons’ shares took another hit this morning, slipping 5% after management advised investors that full-year profits should be “broadly in line with” last year.

Why no growth?

According to the firm, its core markets in the UK, Australasia and Africa are all experiencing “tough trading conditions”. Management has previously noted that inflation in markets such as the UK and Nigeria is forcing consumers to shop more carefully. Mid-market branded products are coming under pressure from cheaper alternatives.

However, I think it’s worth noting that PZ Cussons may have a growth problem if its own. The group’s sales have fallen from a peak of £883.2m in 2013, to just £809.2m in 2016/17. Last year saw sales fall by 1.5%, while adjusted earnings per share were down by 2.1%.

City analysts’ share management’s view that adjusted earnings per share are likely to be flat in 2017/18.

An increase of 6% is pencilled in for 2018/19, but to my mind, the forecast P/E of 18 and prospective yield of 2.7% suggest that this stock is already fully priced.

Total domination?

The acquisition of food wholesaler Booker Group by Tesco (LSE: TSCO) has recently been approved by the Competition and Markets Authority. I’ve been bullish about this deal since it was first announced, as I can see several big attractions for the supermarket (if not for its rivals).

The first is that by taking over the supply of goods to more than 3,000 convenience stores currently supplied by Booker, Tesco will significantly increase its share of this profitable and growing market.

The second attraction is that the combined group will become a major player in the foodservice business, supplying food to restaurant chains.

I expect these new businesses to provide several years of market-beating earnings growth for Tesco, as organic growth combines with cost savings and economies of scale.

Reasonably priced

The supermarket group rejoined the dividend list in October, ending a two-year suspension with an interim payout of 1p per share. Forecasts indicate a total payout of 3.28p per share for the current year, giving a prospective yield of 1.6%.

That’s not very exciting, but broker forecasts suggest that this payout — and Tesco’s earnings — should start to climb rapidly in the 2018/19 financial year.

Merging with Booker should add around £175m to Tesco’s profits, before any cost savings. Current broker estimates are for earnings per share to rise by 30% to 13.1p per share next year. A 58% increase in the dividend is expected, taking the payout to 5.2p per share.

These forecasts leave Tesco trading on a 2018/19 forecast P/E of 16, with a prospective yield of 2.5%. In my view this could be a good entry point for dividend growth investors.

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 has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK owns shares of PZ Cussons. 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

Would Warren Buffett buy BP shares, as oil excitement grows?

Warren Buffett is a big investor in the oil business, and BP's performance has been attracting investor attention in results…

Read more »

Cropped shot of an affectionate young couple posing with a bunch of flowers in their kitchen on their anniversary
Investing Articles

Here’s how long-term loyalty to UK shares can lead to dazzling returns!

The most successful UK and US share investors buy shares to hold for the long term, as this report shows.

Read more »

Investing Articles

NatWest has just smashed brokers’ dividend forecasts!

After NatWest delivered a Valentine’s Day surprise to investors, our writer thinks the experts may have to raise their dividend…

Read more »

Investing Articles

The NatWest share price slips in early trading despite positive FY 2024 results. What’s the deal?

The NatWest share price is down slightly this morning after the bank released its final results for 2024. Our writer…

Read more »

Young Asian man drinking coffee at home and looking at his phone
Investing Articles

My Legal & General shares have climbed just 7% — so how come I’m sitting on a 20% gain?

Harvey Jones' trading account is showing only a modest return on his Legal & General Shares, but on drilling down…

Read more »

Investing Articles

Prediction: the BP share price could rise in 2025 (or it might fall!)

Following this week’s release of the energy giant’s 2024 results, our writer reviews the prospects for the BP (LSE:BP.) share…

Read more »

many happy international football fans watching tv
Investing Articles

What’s gone wrong with the FTSE 100’s ‘King of Trainers’?

Feeling the pain of a 28% drop in the JD Sports share price over the past three months, our writer…

Read more »

Investing Articles

Is it too late for investors to consider buying these outstanding FTSE 100 shares?

Stephen Wright wonders whether now's the time to consider buying shares in the FTSE 100’s outstanding companies, despite some high…

Read more »