In December 2007, the Tesco (LSE: TSCO) share price hit a high of 477p. Since then, it’s been largely downhill for long-term investors. Tesco shares fell below 150p in 2016, before beginning a gradual recovery that’s seen the stock reach today’s price of 225p.
I’ve been a fan of Tesco shares for some time. I believe the UK’s largest supermarket is now a well-run business that should provide steady returns for shareholders. But can the shares return to the 400p+ level last seen in 2011? I’ve been taking a fresh look.
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Let’s start with news that suggests Tesco is serious about improving the reputation of its business. The company has announced that it will repay £585m that it’s saved this year as a result of the government’s business rates holiday.
This measure was originally intended to support struggling retailers during the pandemic. Supermarkets have come in for some criticism this year. That’s because they’ve enjoyed bumper trading conditions and have continued to pay dividends while still benefiting from the business rates holiday.
I reckon this is a smart move by Tesco. Although the company says it’s spent an extra £725m handling the coronavirus pandemic, this rate relief was never intended for companies that were trading strongly. I suspect we’ll see the group’s main rivals follow Tesco’s example over the coming months.
Back to growth?
Tesco’s share price has risen by 11% since the start of November, when the first Covid-19 vaccine results were announced. The Pfizer Covid-19 vaccine has now been approved for use in the UK. Vaccinations are expected to start this month.
I think it’s fair to expect the pandemic to gradually ease next year. I’d guess the extra costs faced by Tesco should also start to reduce. This could put the group in a strong position to return to growth. City analysts covering the stock certainly think so.
The latest consensus forecasts for Tesco shares suggest the group’s earnings will rise by 25% in the 2021/22 financial year. Shareholders are expected to enjoy a 15% dividend hike too.
These estimates put Tesco’s stock on a forecast price/earnings ratio of 13, with a potential dividend yield of 4%. I think that’s attractive and I’d be happy to buy the shares at this level. But how much further can the stock rise?
Will Tesco’s share price return to 477p?
Tesco is already the UK’s largest supermarket. It’s also one of the UK’s largest wholesalers. I think there are limits to how big the business can grow, especially as overseas operations have been heavily cut.
However, I do expect Tesco to be able to continue delivering steady earnings growth each year. Looking ahead, I’d guess we might see earnings per share rise by around 5% each year.
Using this as a guide, I’ve played around with the numbers. My results suggest to me the Tesco share price is unlikely to return to 477p for the foreseeable future. Even on a 10-year view, that seems a little steep to me.
I’d be happy to buy Tesco shares for their yield, but I wouldn’t expect fireworks.