Why I still see the Tesco share price as one to be avoided

Here’s why I think Tesco plc (LON: TSCO) shares are set for years in the doldrums.

| 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.

There’s no doubt that Tesco (LSE: TSCO) is a leaner, fitter operator than it’s been for some years, and its share price reflects that with a gain of 19% over the past 12 months (compared to a 6.5% drop in the FTSE 100).

But that comes after 2018’s earlier optimism has started to fade, culminating in an 8.5% share price dip on the day of the supermarket giant’s interim results on 3 October.

Tesco reported generally positive figures across the board, with sales up 12.8%. And a 67% hike in the interim dividend, while taking it to only a modest 1.67p per share, is a move in the right direction.

Margins tight

But operating profit didn’t sparkle, falling by 6.5% in reported terms, and by 1.4% on a “retail operating cash flow” basis. That’s important to me, as it puts the focus where it needs to be — on the fact that this is a very low margin business, whatever margins chief executive Dave Lewis is aiming for.

It’s also reinforced by the opening of Tesco’s new cut-price chain Jack’s, named after company founder Sir Jack Cohen, which aims to compete head on with Lidl and Aldi. But for me, that raises a couple of questions. Why can’t Tesco just compete with them anyway? And why has it taken so long to address the only thing that really matters in the groceries business?

That brings me to why I just wouldn’t buy supermarket shares, whether it’s Tesco, Sainsbury, or Morrisons (or even Aldi or Lidl, if they were available).

Poor differentiation

I see the groceries business as a fine example of economic efficiency. It’s occupied by a number of players of various sizes, all offering essentially the same interchangeable goods with little or no real differentiation — it matters nothing to me what label is on a can of whatever I’m buying, and that’s increasingly the case with hard-pressed shoppers.

And, with a few exceptions, they are increasingly competing only on price. Even Sainsbury, which has long prided itself on offering a slightly upmarket service, is aiming for a merger with Asda to help get prices down.

Competitive advantage

But while it’s great for consumers, an economically efficient market is perhaps not what investors should do best from. What we should prefer, surely, is a market with significant product differentiation and with clear defensive positions — the kinds of things that provide the best companies with significant market advantage over their competitors, and so support higher margins.

It’s also largely why I’ve never invested in airlines. In the most part, they offer exactly the same service and compete only on price. I know some, like easyJet, have done very well — but in the decades I’ve been investing, very few have really been big successes.

Time will tell

Tesco’s recent progress has been looking good now that it has been doing the big things — the purchase of Booker Group wholesaler was a particularly canny move, I reckon. But it’s the small things over the coming years that will matter, the day-to-day competition on price.

And on that score, I don’t see any significant attraction in Tesco over anyone else. 

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.

Alan Oscroft has no position in any of the shares 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

Young Caucasian man making doubtful face at camera
Investing Articles

My Diageo shares stink! What should I do with them?

Diageo shares are having a negative impact on Edward Sheldon’s investment portfolio at the moment. Should he cut his losses…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

5 things that make me nervous about Barclays shares!

After more than doubling over the past year, Barclays shares are riding high. But the road ahead could be bumpy…

Read more »

Silhouette of a bull standing on top of a landscape with the sun setting behind it
Investing Articles

3 reasons the NatWest share price could keep climbing

The NatWest share price has almost doubled in the last 12 months. But Stephen Wright thinks it might not be…

Read more »

Investing Articles

Billionaire’s hedge fund bets big against the GSK share price!

After years of limping along, the GSK share price has leapt 11% in one month. But one of America's richest…

Read more »

Investing Articles

Now at a 52-week high, can the Scottish Mortgage share price go even higher?

The Scottish Mortgage share price is firing on all cylinders, driven higher by outstanding progress at many of the trust's…

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

FTSE shares: the perfect ‘get rich slow’ idea?

As a long-term investor, Christopher Ruane reckons the FTSE 100 could offer him the foundations to create stock market wealth.…

Read more »

Investing Articles

Here’s how an investor in their 30s could aim to turn a £10k ISA into £132,676 by retirement

Christopher Ruane explains how someone with a 30-year investing timeframe could aim to increase an ISA stuffed with blue-chip shares…

Read more »

Investing Articles

£10,000 invested in Rolls-Royce shares 5 years ago is now worth…

Rolls-Royce shares have made a lot of investors very rich as they push to new heights. Dr James Fox explores…

Read more »