Why I’d shun this FTSE 250 dividend stock and buy the Tesco share price

Rupert Hargreaves explains why he believes Tesco plc (LON: TSCO) is a much better buy than this struggling FTSE 250 (INDEXFTSE: MCX) dividend stock.

| 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.

Historically, British companies have had a hard time trying to crack the US market. Even Tesco (LSE: TSCO), the UK’s largest retailer, tried and failed to break into the USA. The group admitted defeat in 2013, selling its chain of 199 Fresh & Easy shops in 2013 for a loss of £1.2bn. 

Cineworld (LSE: CINE), however, believes it can succeed where others have not. Last year, the company spent $5.8bn to acquire US cinema group Regal Entertainment. 

So far, it seems as if the enlarged group is making progress, but I believe investors should stay away. 

High-risk bet

Cineworld’s hostile takeover of Regal was a high-risk bet by management. As well as a rights issue, Cineworld took on a staggering $4.1bn in debt to fund the deal. 

Today the company revealed its first set of results following the merger, which completed in February. For the six months to the end of June, admissions, revenue and profit before tax, increased 143%, 252% and 165% respectively.

Management is confident that this performance can be repeated in the second half. Indeed, according to CEO Mooky Greidinger, the second half  has “started well with the release in July of ‘Mission Impossible: Fallout’, ‘Mamma Mia! Here We Go Again’ and ‘Equalizer 2’.

But despite the group’s rising profitability, what concerns me is Cineworld’s debt. At the end of June, adjusted net debt was $3.9bn, up from $3.3bn at the end of 2017 and equal to 3.8 times adjusted earnings before interest tax depreciation and amortisation (EBITDA). Generally, when looking for investments, I rule out any companies with debt-to-EBITDA ratios of more than two times.

What’s more concerning is that Cineworld’s debt facilities are subject to floating interest rates. With interest rates rising, it is only going to become more costly for the group to meet its obligations in the months and years ahead. 

Considering all of the above, I’m avoiding Cineworld despite its 4.4% dividend yield and relatively low forward P/E of 13.9 (although my colleague Jack Tang seems to disagree).

Growth and income 

Instead of Cineworld, I would buy a recovery play Tesco. The UK’s largest retailer has come a long way since its accounting scandal in 2014/15. And now the group is aggressively chasing market share with the launch of a new discount brand to take on the likes of Aldi and Lidl as well as a buying agreement with French retailer Carrefour.

Together, these initiatives should help the group push down prices and push up profits. City analysts are expecting the company to report earnings growth of nearly 30% for fiscal 2019, followed by an increase of 20% in 2020. 

At the same time, Tesco’s dividend to investors is expected to more than double to 7.1p, giving an estimated dividend yield of 2.7% at current prices. 

Unlike Cineworld, Tesco has also been working on reducing debt over the past five years. Net debt has fallen from £6.6bn to £2.6bn at the end of fiscal 2018, which is around 1.1 times free cash flow from operations (for fiscal 2018). 

So overall, with its strong balance sheet and growing dividend, Tesco looks to me to be the better buy. With its mountain of debt, I couldn’t sleep comfortably owning Cineworld.

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.

Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Tesco. 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

2 industry-leading value stocks investors should consider buying

These value stocks are at the top of their respective industries, and look like current bargains with the potential to…

Read more »

Black father and two young daughters dancing at home
Investing Articles

Just released: our 3 top small-cap stocks to buy before August [PREMIUM PICKS]

Small-cap shares tend to be more volatile than larger companies, so we suggest investors should look to build up a…

Read more »

Investing Articles

If I’d put £5k in a FTSE 100 index fund 10 years ago, here’s what I’d have now!

Charlie Carman explores the performance of the FTSE 100 index over the past decade and the merits of passive versus…

Read more »

Investing Articles

£15K stashed away? I could turn that into a second income worth £49 a day!

This Fool explains how she would look to gain a second income through investing in UK stocks, and the steps…

Read more »

Smiling white woman holding iPhone with Airpods in ear
Investing Articles

With the Apple share price near an all-time high, would I be crazy to buy more?

After touching all-time highs yesterday, the Apple share price is on a roll. But is there still enough growth ahead…

Read more »

Investing Articles

Nvidia stock has fallen 13% from its 52-week high! What next?

Our writer explains why Nvidia stock has dipped recently and highlights some risks associated with investing in the AI leader…

Read more »

Investor looking at stock graph on a tablet with their finger hovering over the Buy button
Investing Articles

The AstraZeneca share price is up 88% in 5 years, but is it just getting started?

The AstraZeneca share price has had a great few years, as acquisitions and clinical trials delighted shareholders. So is there…

Read more »

Investing Articles

Here’s why I’m watching the Anglo American share price

The mining sector has always interested investors. But after a flat few years, I'm wondering what's next for the Anglo…

Read more »