Back in February, it was reported that Tesco (LSE: TSCO) had a ‘secret plan’ to develop a new discount grocery chain. The UK’s largest supermarket was taking such measures in an effort to stop the migration of its customers to the German discounters Aldi and Lidl.
Fast forward seven months and Tesco has just unveiled its new low-price chain, which is named Jack’s. So, what are the details and how does this development affect the investment case?
Tesco’s new discount chain
Tesco’s new Jack’s stores will sell around 2,600 ‘essential’ items, of which around 1,800 products will be own-branded products – a format similar to that of the German chains. The stores will be a mixture of entirely new sites, converted Tesco stores and sites adjacent to existing Tesco stores. While the first two stores will open today in Chatteris and Immingham, the group is only planning to open 10-15 in the next six months, although it does have the option to open more if things go well.
Does this news impact the investment case for Tesco? No, in my view. To be honest, I don’t think Aldi and Lidl will be too concerned about 10-15 Jack’s stores. To put that number in perspective, Lidl opened its 700th store in the UK earlier this year and has plans to open 50 new sites this year, while Aldi currently has over 750 stores in the UK and plans to have more than 1,000 by 2022.
In my opinion, Tesco shares still look slightly overpriced at the current price. With analysts expecting the group to generate earnings of 14.1p per share this year, the stock’s forward-looking P/E ratio is 16.7 at present. I don’t see much value there when you consider how competitive the industry is right now. Similarly, Tesco’s prospective dividend yield of just 2.1% does not offer much appeal when you consider that the median FTSE 100 forward-looking yield is 3.6%. As such, I believe Tesco remains a share to avoid for now.
What about rival Sainsbury’s (LSE: SBRY)? Is that a stock worth buying?
Well, there was news here yesterday too, with the Competition and Markets Authority (CMA) advising that it is referring the proposed merger with Asda for a further “in-depth” investigation. Having completed its Phase 1 investigation into the merger, the CMA stated that the deal “raises sufficient concerns” to be referred for a deeper review as there is plenty of overlap between Sainsbury’s and Asda stores, meaning that shoppers could potentially “face higher prices or a worse quality of service.”
So, right now there’s a fair bit of uncertainty as to whether the deal with Asda will go ahead. As such, I believe it’s worth waiting to see how things play out, before making a decision on the shares. With the stock up 32% year-to-date and currently trading on a forward P/E ratio of 15.2, there’s risk to the downside if the deal falls through, in my view.